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With so many different descriptions of income on your tax return, it's easy to get the terms mixed up. However, if you use the wrong amount, you could end up missing out on a deduction you're eligible to claim, costing you money, or claiming a child as a dependent when he's ineligible, getting you in hot water with the Internal Revenue Service.
Your gross income includes all of your income that you received that isn't exempt from income taxes. It does not include any losses. For example, if you have $50,000 in wage income and $3,000 in net stock losses, your gross income would be $50,000. Gross income does include your net business income. For example, if you're self-employed and have gross receipts of $60,000 and business expenses of $20,000, your gross income would be $40,000.
Gross Income Significance
Gross income reflects how much money you made during the year, and it determines whether you have to file a return. In addition, your gross income determines whether someone can claim you as a dependent, and that person's gross income determines whether you can claim him. For example, you're still paying for your child's graduate school tuition and all of his other expenses, but he's too old to be claimed as a dependent child. If his gross income is more than the annual limit, you can't claim him.
Adjusted Gross Income
Your adjusted gross income equals your gross income minus your adjustments to income. Sometimes adjustments to income are informally referred to as above-the-line deductions, because you can take them without itemizing. Examples include your deductible traditional IRA contributions, alimony paid, health insurance if you're self-employed and student loan interest. Other deductions, such as the standard deduction, itemized deductions including mortgage interest and charitable deductions and exemptions aren't used to figure your adjusted gross income.
Your adjusted gross income isn't the final income number used to figure your tax bill, but it's important none the less. It's used to determine your eligibility for several deductions, including the medical expenses deduction and miscellaneous deductions. Although your adjusted gross income is calculated on your federal tax return, its significance isn't limited to your federal taxes. Many states use your federal adjusted gross income as the starting point for figuring your state income taxes.
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