Our blogs are written to help make tax compliance and planning processes easier to understand for non-tax professionals. Though many of our articles provide keen insight in easy-to-understand language, we are sometimes guilty of inadvertently peppering our articles with industry jargon, “tax talk,” or abbreviations that you many not easily recognize. So, we thought it would be helpful to our readers to provide a brief explanation of frequently used tax talk words in a monthly “Tax Talk Glossary.” Read on for our first installment where we discuss types of income.
“What is the difference between a taxidermist and a tax collector? The taxidermist takes only your skin.” –– Mark Twain
This month we begin by defining tax vocabulary related to the term “Income.” For non-accountants, income is often considered the money you make – from your job, your business, etc. However, the IRS has various definitions for income and each of those definitions are used to determine your tax, allowable deductions, credits, etc.
Gross Income is income from all sources – wages, interest, dividend, sale of stocks, rental properties, business, retirement, social security, gambling, etc. – that is NOT specifically exempt under any IRS code section. The key words here are “not specifically exempt.” Under various IRS code sections, partial or complete exemptions are available for certain types of income. An example of partial exemption would be amounts received under an employer provider educational assistance program; you can exclude up to $5,250 from your gross income. An example of 100% exclusion would be interest income from most municipal bonds.
Did you know even income from illegal or criminal activities are required to be included in gross income? If you Google “Al Capone tax,” you can learn all about that fun fact!
Adjusted Gross Income - AGI
You may have heard your accountant say, “you might qualify for this credit if your AGI is below $200,000.” Well, AGI is an abbreviation of Adjusted Gross Income. AGI is the income that is left after certain adjustments to your Gross Income. An example of an “adjustment to AGI” would be amount that you contribute towards your retirement account(s). Tuition and fees and student loan interest are among other allowable adjustments to Gross Income in calculating AGI.
As you can see, the IRS is not as bad as the Mark Twain quote above suggests; they recognize your need to keep some of your hard-earned money. A lot of deductions and credits (to be defined in a later Tax Talk Glossary post) are determined based on the AGI; therefore, it is very important to get this number right.
Modified Adjusted Gross Income - MAGI
MAGI is a variation of AGI. Certain adjustments or exclusions that are allowed while calculating AGI are not allowed while calculating MAGI. In other words, MAGI is a behind-the-scenes calculation where AGI is modified for use in other calculations.
MAGI = AGI + disallowed adjustments or exclusions
Why do we need to know the MAGI? Certain deductions and credits are calculated using MAGI instead of AGI. For example, the current maximum amount of Child Tax Credit per child is $2,000; but this amount may be reduced depending on a taxpayer’s MAGI.
What is the difference between AGI and MAGI? While AGI has fixed adjustments that are deductible from Gross Income; MAGI is calculated differently for certain deductions and credits, so there is no one definition for MAGI.
Taxable Income is the amount of your income used to determine your tax liability. It is calculated by subtracting certain deductions from your AGI (not to be confused with the deductions from your Gross Income to determine AGI). Most of the deductions used to calculate your Taxable Income are itemized or standard deductions (both terms will be covered in another Tax Talk Glossary post). There is also a special deduction for businesses, which we’ve written about extensively in other blogs (search “199A” on our web site to find those articles.
We hope you found this Tax Talk Glossary helpful. Are there other terms you’d like us to cover in future editions? Leave us a comment below!