Adjusted Gross Income, Taxable Income and Tax Liability Explained
By SimplyCPA · 11 October 2026
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- AGI: Gross income minus above-the-line adjustments. It matters because so many limits and phase-outs are based on it.
- Taxable income: AGI minus the greater of the standard or itemized deductions, minus the QBI deduction and other deductions from AGI.
- Tax liability: Apply the brackets progressively — each rate applies only to income within its band.
- Marginal vs effective: The marginal rate is the rate on the next dollar; the effective rate is total tax ÷ income.
- Credits vs deductions: A deduction reduces income; a credit reduces tax dollar for dollar.
Step 1: gross income
Gross income includes all income from whatever source unless an exclusion applies. Common exclusions: gifts and inheritances, life insurance proceeds paid on death, municipal bond interest, qualified scholarships, and up to $250,000 ($500,000 joint) of gain on selling a main home.
Step 2: adjustments to reach AGI
Above-the-line adjustments include deductible traditional IRA contributions, health savings account (HSA) contributions, the deductible half of self-employment tax, self-employed health insurance, student loan interest (up to $2,500), and educator expenses.
Step 3: deductions from AGI
- The greater of the standard deduction and itemized deductions.
- The qualified business income (QBI) deduction under Section 199A — made permanent by the OBBBA.
- For 2025–2028, the deductions for qualified tips, overtime pay, car loan interest and seniors.
Worked example (2026, single filer)
| Salary | $95,000 |
| Interest income | $1,000 |
| Municipal bond interest (excluded) | $0 |
| Gross income | $96,000 |
| − Traditional IRA contribution (not covered by a workplace plan, so fully deductible) | ($7,500) |
| AGI | $88,500 |
| − Standard deduction (itemized deductions are only $9,000) | ($16,100) |
| Taxable income | $72,400 |
Tax on $72,400:
- 10% × $12,400 = $1,240
- 12% × ($50,400 − $12,400) = 12% × $38,000 = $4,560
- 22% × ($72,400 − $50,400) = 22% × $22,000 = $4,840
- Total = $10,640
Marginal rate = 22%. Effective rate on taxable income = $10,640 ÷ $72,400 = 14.7%; on gross income = 11.1%.
Step 4: credits and other taxes
- Nonrefundable credits (most education credits, the non-refundable part of the child tax credit) reduce tax to zero but not below.
- Refundable credits (earned income credit, the refundable part of the child tax credit) can produce a refund.
- Other taxes are added: self-employment tax (15.3% on net earnings up to the Social Security wage base, 2.9% above it), the 3.8% net investment income tax above $200,000 MAGI ($250,000 joint), and the 0.9% additional Medicare tax above the same thresholds.
Exam trap: Moving into a higher bracket never reduces take-home income — only the income above the threshold is taxed at the higher rate. Questions that suggest "a raise put me in a higher bracket so I earn less" are testing this.
Learn more in tax credits vs deductions and our REG notes on gross income and adjustments and deductions.