Tax Return

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When calculating your income for tax purposes, you may hear the terms "gross" and "net". Gross income includes (almost) all of your income, while net income is the end result after various tax deductions are applied. Here's what these terms mean, as well as another important income figure to know.

Gross income
In a financial context, the term "gross" generally means all of something. For example, on your paycheck, "gross pay" refers to the entire amount of money you get paid, before taxes and other deductions come out.

Similarly, gross income refers to all of your income, including but not limited to

  • Wages, salaries, and tips.
  • Business income.
  • Capital gains and dividends.
  • IRA and retirement plan distributions.
  • Royalties.
  • Alimony.

However, gross income does not include certain income sources, including these common examples:

  • Gifts and inheritance.
  • Social Security benefits (some SS benefits are tax-exempt and therefore are not included in gross income, depending on the amount of your benefit and any other income you receive).
  • Life insurance proceeds.
  • Tax-exempt interest (for example, if you own municipal bonds, the interest isn't taxable on a federal level).
  • Scholarships received.
  • Some elective payroll deferrals, such as 401(k) contributions.

Adjusted gross income
The key number to know for tax purposes is adjusted gross income, as it is the baseline income figure used to determine your taxable income. Plus, many deductions and credits use AGI to determine eligibility.

Adjusted gross income is your gross income with certain allowable deductions taken out, known as "above-the-line" deductions. Specifically, the following items are not included in adjusted gross income.

  • Educator expenses.
  • Health savings account contributions.
  • Qualified moving expenses.
  • Half of the self-employment tax.
  • Allowable retirement contributions, including traditional IRAs.
  • Alimony paid.
  • Tuition, fees, and student loan interest.
  • Jury duty pay remitted to your employer.

It's important to note that many of these have limits and qualifications. For example, the deduction for educator expenses is limited to $250 per year, and you must have been a full-time employee in a K-12 school.

Net (taxable) income
Finally, net income (or taxable income) is calculated by taking your AGI and subtracting your allowable deductions and exemptions.

For the 2015 tax year, exemptions are worth $4,000 for yourself, your spouse, and for each of your dependents. You can also choose to itemize your deductions or use the standard deduction listed in the following chart.

Filing Status

Standard Deduction

Single

$6,300

Married filing jointly

$12,600

Married filing separately

$6,300

Head of household

$9,250

Qualified widow/widower

$12,600

For example, let's say your total income from all sources for the year is $100,000. Your above-the-line deductions are as follows:

  • Student loan interest: $2,000.
  • Traditional IRA contributions: $4,000.

This means your adjusted gross income is $94,000. If you're married with two children and choose to take the standard deduction of $12,600, your net (taxable) income is:

Adjusted gross income (AGI)

$94,000

Exemptions (4)

-$16,000

Standard deduction

-$12,600

Net (taxable) income

$65,400

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