Taxes: Net Amount vs. Gross Amount

As a general rule, "gross" means all of something. Gross income refers to an individual's entire income from all sources -- wages, self-employment, bonuses, dividends, etc. Net income is the number that matters for tax purposes, and refers to your income after adjustments, deductions, and credits are subtracted from your gross income.

However, there's a little more to it than that. When calculating your net (taxable) income, there's another important figure -- adjusted gross income, or AGI. Here's what you need to know about gross, net, and adjusted gross income on your taxes.

Gross income -- earned income and other income

Gross income consists of all of your income from taxable sources. It consists of your earned income, which includes:

• Wages
• Salaries
• Tips
• Bonuses
• Self-employment income

Additionally, gross income includes all other sources of income. Just to name a few common sources, this can include:

• Capital gains
• Interest income
• Dividends
• Rental income
• Unemployment benefits
• Royalties
• IRA/401(k) distributions
• Social Security benefits (depending on your income)
• Pensions
• Annuities

It's also important to point out that only the taxable portions of some of these items will count toward gross income. For example, if you have qualified distributions from a Roth IRA, those are not considered to be taxable income, and therefore are not included in your gross income.

Adjusted gross income

Adjusted gross income, or AGI, is your gross income minus certain adjustments.

These adjustments are also known as "above-the-line" deductions because they can be taken whether or not you choose to itemize deductions on your tax return. The list of adjustments could change over time, but as of this writing, the IRS's adjustments to income include:

• Tuition and fees
• Student loan interest
• Educator expenses
• Alimony paid
• Moving expenses, if the move was related to starting a new job
• Bad (uncollectible) debts owed to you
• Contributions to a traditional IRA

Some of these are subject to limitations and other qualifications. For example, the maximum deduction for tuition and fees is $4,000, and this cannot be taken if you use one of the education credits.

By subtracting your adjustments from your gross income, you can appropriately calculate your adjusted gross income, or AGI.Here's an example calculation of AGI for a married couple with gross income of $100,000.

AGI is important for a few reasons. First of all, many tax breaks are based on AGI. Just to name a couple, the education tax credits and mortgage insurance deduction are subject to AGI limitations. Also, lenders often use your AGI to determine whether or not you qualify for a loan.

Net, or taxable income

There are two more things to subtract from AGI before you arrive at your net, or taxable income -- exemptions and deductions. For the 2016 tax year, you can subtract a $4,050 personal exemption for you, your spouse, and any dependents you claim on your tax return.

When it comes to deductions, you can choose between the standard deduction, which currently is $6,300 for single filers and $12,600 for married joint filers, or you can itemize deductions if it adds up to more than the standard amount. Once you subtract these things, the result is your net income, which will be used to calculate your taxes.

Continuing our AGI example above, let's say that this married couple has two children, which means a total of four personal exemptions -- or $16,200. And for simplicity's sake, we'll say they take the $12,600 standard deduction -- most Americans do. Subtracting these two items reveals a taxable income of $60,950.

Finally, it's important to mention that not all income is taxed the same. Most taxable income is subject to the income tax brackets, while qualified dividends and long-term capital gains are taxed at more favorable rates.

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center, in general, or this page, in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!