Taxable Income vs Gross Income: What Are You Actually Taxed On?

Your salary might be $100,000, but the IRS (hopefully) doesn’t tax you on $100,000. Understanding the difference between Gross Income (what you earn) and Taxable Income (what you pay on) is the foundation of tax planning. The bridge between them is the “Magic Number” known as AGI (Adjusted Gross Income). Here is the exact formula to shrink your taxable number legally.

BMT Tax Team BMT Tax Team · 📅 Feb 2026 · ⏱️ 5 min read · TAX TIPS › BASICS
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1. The Rule: The Tax Funnel

Think of your taxes as a funnel. You want the bottom hole to be as small as possible.

The Formula
1. Gross Income (Everything in)
minus Adjustments (401k, HSA, Student Loan Interest)
= AGI (The most important number)
minus Standard/Itemized Deduction
= Taxable Income (The Bill)

2. Visualizing the Difference (Checklist)

See how a $100k salary becomes a $70k tax bill.

Stage Example Amount What affects it?
Gross Income $100,000 Salary, Bonus, Side Hustle, Dividends.
AGI $90,000 Reduced by 401(k) & HSA contributions.
Taxable Income $73,900 Reduced by Standard Deduction ($16,100).

3. Timeline: The “Deduction Waterfall”

Deductions are not all equal. “Above the Line” (Stage 1) is worth more than “Below the Line” (Stage 2).

Step Action Impact
Step 1
(Gross ➔ AGI)		 401k / HSA
Lowers AGI (Unlocks Credits)
Step 2
(AGI ➔ Taxable)		 Standard Ded
Lowers Bill (Fixed Amount)
Step 3
(Final Bill)		 Tax Rates
Apply Brackets to Remainder
Planning Note
If your income is close to a “phase-out limit” for Roth IRAs or Child Tax Credits, prioritizing “Above-the-Line” deductions (like maximizing a Traditional 401k) is generally the only way to lower your AGI enough to qualify.

4. Strategy: Why AGI Matters More

Lowering AGI is the holy grail of tax planning.

  • The Gatekeeper: Your AGI determines your eligibility for almost everything: Roth IRA contributions, EV tax credits, Financial Aid (FAFSA), and Medicare premiums (IRMAA).
  • The Strategy: Charitable donations (Itemized Deduction) lower your Taxable Income, but they do NOT lower your AGI.
  • The Lesson: If you need to qualify for a Roth IRA, donating to charity won’t help. Contributing to a 401(k) will.

5. Warning: The “MAGI” Twist

Just when you figured out AGI, the IRS adds a letter.

⛔ Modified AGI (MAGI)

For Roth IRAs and Student Loan deductions, the IRS uses MAGI.

  • The Calculation: Start with AGI, then “add back” certain deductions (like foreign income or rental losses).
  • The Trap: Your AGI might look low enough, but your MAGI could be just over the limit, causing penalties.

6. Frequently Asked Questions

Does mortgage interest lower AGI?
No. Mortgage interest is an “Itemized Deduction” (Below the Line). It lowers your Taxable Income, but it does not lower your AGI.
Does my 401(k) match count as income?
No. Employer contributions to your 401(k) are generally not included in your Gross Income or Taxable Income. It is “free money” that is also tax-deferred.