What you need to know about Adjusted Gross Income (AGI)

Everyone from individual taxpayers to small businesses has likely heard about gross income or total annual income. This is the total amount of money you'll make from working. While it's important and a helpful indicator of how much money you may have made, gross income is just one part of the income big picture. As a small business owner, you’ve likely heard of Adjusted Gross Income (AGI.) AGI is the gross income of your business for the year minus adjustments. It’s the amount of money the IRS determines as your income tax liability for the year, which just means how much you may owe. AGI is important for small business owners to understand what adjustments (or deductions) need to be accounted for during tax time. Ahead, we’ll dive into what exactly AGI is, what a small business needs to calculate AGI, and how to do it. We'll also share one great app that'll make the process a lot easier, and a lot faster, saving you time, money, and more than a few headaches.

What is Adjusted Gross Income?

Adjusted gross income (AGI) is a business (or person’s) total income that has been adjusted for any specific payments made throughout the year. These deductions impact how much income is deemed taxable by the government, which may mean a lowered business income tax payment. Your deductions may include:

• Operating costs
• Payroll operating costs
• Inventory
• Insurance
• Rent or mortgage
• Marketing
• Employee salaries or wages

These are just a few examples of why or where deductions can be made. It's important to note the Internal Revenue Services (IRS) determines each business’s specific adjustments, so you'll want to check with a professional to ensure you're following their rules. TL;DR? AGI = total annual income - eligible deductions AGI is different from regular gross income. With gross income, which can be salary or hourly wages paid (including tips), the amount is set before deductions. Your annual gross income is your overall total for the year before any deductions or taxes. AGI works sort of in reverse where deductions are considered first, and then the amount after those deductions becomes the taxable income. For the most part, AGI is what you’ve earned for the year after all eligible deductions have been applied. These deductions impact how much taxable income you actually have that the government is eligible to say you need to pay taxes on. The lower your AGI is, the lower your taxable income is, too. Important note: not all deductions are eligible across the board so it’s important to understand and research this, or have payroll and tax software that can help automate the process for you and your business.

AGI calculation example

Let's look at an oversimplified example (since hey, we all know there are a lot more expenses to running the business than just the below). Pretend your business earned $300,000 last year. You paid out $150,000 in wages, plus $36,000 in rent. Your business's gross income = $300,000 Your deductions = $186,000 That means your AGI, or new total taxable income, is $114,000. This is a fairly easy and uncomplicated example of how to get AGI but if you have all of the receipts for eligible deductions, plus all of your income statements, including both taxable and non-taxable, you’ll be able to easily follow the formula.

Examples of the Importance of AGI

Calculating your Adjusted Gross Income (AGI) is pretty straightforward. Here’s how you do it with a simple example:

• Example 1: Say you earned $60,000. You put $3,000 into a traditional IRA, and you have $1,500 in other adjustments. Your AGI is $60,000 - $3,000 - $1,500, which equals $55,500.
• Example 2: For something a bit more complex: You earned $120,000, with $80,000 from wages. You contributed $10,000 to a self-employed retirement plan and have $7,500 in other adjustments. Your AGI here is $120,000 - $10,000 - $7,500, landing at $102,500.

Why AGI Matters for Small Business Owners:

1. Taxes: Your AGI influences your tax bill. A lower AGI can mean less tax to pay because it might place you in a lower tax bracket.
2. Tax Breaks: A lot of tax credits and deductions are off-limits if your AGI is too high. Keeping your AGI in check helps you snag these benefits, like the Child Tax Credit or deductions for student loans.
3. Planning: Knowing your AGI gives you a clear picture of what you’re really earning, which is key for mapping out your business’s future. It helps with decisions like reinvesting or taking money out of the business.
4. State Taxes: Your federal AGI usually sets the stage for your state taxes, too. Lowering your federal AGI can also lower what you owe the state.
5. Loans and Credit: When you apply for loans or credit, lenders look at your AGI, not just gross revenue. A better AGI means better chances at approval and favorable terms.

Getting your AGI right is a big deal. It can save you a chunk of change on taxes and help in financial planning. Talking to a tax pro can help you make the most of these strategies.

Modified Adjusted Gross Income (MAGI)

There's a subsection of AGI that may be relevant to your tax preparation. That's Modified Adjusted Gross Income (MAGI). MAGI is defined as any AGI after any tax-exempt interest income and specific tax deductions. Some government programs and tax calculations need the MAGI number specifically. Both AGI and MAGI are linked to the other. To get the MAGI number, you first need to understand what your AGI figure is after total annual income minus deductions. Some deductions will then be added back for your MAGI number—this can include tuition, for example. In some cases, your AGI and MAGI numbers will be very close. For the most part, MAGI is used to determine contributions to Roth investment accounts. If your taxes are relatively uncomplicated, this won’t likely be a factor.

Why Does a Small Business Need to Calculate Adjusted Gross Income?

AGI is an important indicator for your small business. It helps you know how much you’ve made, or how much you may owe in taxes, based on eligible deductions. These deductions are costs you’ve already put into your business. For example, you may be a start-up small business with a different set of needs than an already established small business. If you’re in this position, you may be eligible for first-year adjustments and credits that only appear at this time. But you'll need to calculate AGI for more than just your business; AGI needs to be calculated for your employees, too. They have eligible tax deductions that need to be accounted for. Your AGI is important to determine your AGI bracket. If you have a higher AGI, you may need to have funds allocated to pay those taxes, after deductions are taken into account. If your AGI is lower and falls in a different spot of the taxation bracket, your business may be eligible for other credits or adjustments. You need to know how much you’ve put into your business and where to see what’s eligible for adjusting your overall gross income. AGI can impact how much you owe in taxes or if you’re in the position for more adjustments. It’s important to calculate AGI so you know where you stand at tax time.

How to Calculate Adjusted Gross Income

Now that you know what AGI is, and what it means for your small business’s taxes, let’s figure out how to calculate it. Below we’ve got you covered on everything you need to calculate your business’s AGI.

1. Find your income statements

Let’s start with the easiest part of calculating AGI: collecting your income statements. Your income statements include a W-2 for pay, like salary and wages, and if you’re self-employed, anything that might need to be reported there. But your income can be broken down into two specific categories: taxable income and non-taxable income. These also contribute to your overall annual income. Let's start with taxable income. Your taxable income can include something as easy to figure out as business income, severance, or unemployment benefits. If those occurred in the same tax year as your small business began its start-up, which is your primary taxable income as a business, you’d need to claim those as taxable income.

Other taxable income you may need to include are:

• Long-term disability benefits
• Fees such as jury duty
• Winnings from prizes such as the lottery, awards, and even gambling
• Any earned money from real estate
• Capital gains
• Spousal support (alimony payments)

For non-taxable income, this refers to payments made to you that you won’t be taxed for. They don’t fit into the categories above but they still need to be reported to the IRS and included on your tax return.

Non-taxable income includes:

• Worker’s compensation benefits
• Child support payments
• Disability payments
• Any scholarship or grant funding
• Money received as a gift
• Canceled debts or loans
• Capital gains from selling your primary home

To keep things neat and tidy at tax time, keep separate folders for taxable and non-taxable income online and offline, creating subfolders relevant to you. Ensuring you have receipts, income statements, and forms—and any other document referring to your taxable or non-taxable income—ahead of time will make calculating your AGI a lot easier when you need to. An app like Homebase can help streamline and take the fuss out of complicated tasks. It's an easy way to skip the paperwork and automate calculation, payment, and tax filings, keeping everything you need in one place.

2. Determine your total annual income

Your next time in calculating AGI is to figure what your total income is. You do this by adding up all of the money you’ve made in a year. Include bonuses you’ve given yourself, or have been given to you. If you’re a salaried employee, a lot of this is already done for you on your income statement. Small business owners will be able to do this through their payroll software. Homebase, for example, can calculate all wage and tax deductions for you, as well as any other nuances like additional costs and schedules. Bonus: payroll information, like how much an employee’s salary is and how much to pay them, is automatically processed. If you’re an hourly or wage worker, especially with multiple jobs, you’ll need your wage amount, hours worked per week, and then multiply that by 52 to see the total annual income. Again, payroll software will be able to do this for small business owners with hourly employees. Salaried employees aren’t the only ones to receive this benefit of automation.

3. Take the sum of your deductions

Now that you’ve collected all of your income statements, taxable income, and non-taxable income, it’s time to look through what deductions and adjustments there are for your AGI. It’s absolutely crucial to keep records of all receipts, payments, documents, anything that may impact an adjustment. This is what you’ll refer to in order to calculate the overall sum of adjustments that need to be made. It’s likely that adjustments may change each year. Small business owners paying taxes will have similar deductions to make each year, but it’s good to know some of the different categories of deductions that can be made in case you qualify one year for that credit. Some deductions include:

• Business expenses relevant to your business
• Moving expenses
• Health spending account contributions
• Health insurance premiums if self-employed
• Self-employment taxes

Any deduction must qualify and meet certain requirements set out by the IRS. Do extra research if you’re unsure about a deduction, and if it’s eligible for inclusion for your AGI.

4. Subtract your deductions from your total annual income

Now that you have your total annual income amount and eligible deduction amount, you’ll be able to determine your AGI. AGI = total annual income - eligible deductions

Homebase makes calculating your adjusted gross income easier

If this is all seeming a little complicated for you, not to worry: we're here to help. Homebase makes calculating adjusted gross income easy for you and your employees. With Homebase’s automated payroll process, you’ll be able to clearly see timesheets become wages and hours worked—and so will your employees. This makes calculating total annual income for your employees a lot easier. Homebase is enabled to calculate federal taxes and specific state taxes, and send payments to employees, states, and the IRS all in one easy system. Homebase saves you time and energy by simplifying data entry, reducing errors, and streamlining the process to calculate AGI. Plus, Homebase even submits new hire reporting and files W-2 forms for you. And just because we know how complicated managing a small business can be, Homebase even stores your time card and payroll records to help you stay compliant with FLSA record-keeping rules. Understanding adjusted gross income and what it means for your small business, doesn’t need to be a headache. Knowing about AGI helps you figure out what you’ve really made after you take all the things that’ve gone into your business into consideration. As the saying goes, it’s just death and taxes.