There are different types of income for tax purposes. How the Internal Revenue Service (IRS) defines them and how taxpayers calculate them affects the amount of taxes they will pay. Modified adjusted gross income (MAGI) is one of them.
What is modified adjusted gross income?
Modified adjusted gross income is the amount taxpayers use to determine whether they qualify for certain tax deductions, including the deductibility of contributions to 401(k), traditional and Roth IRAs, and interest on student loans.
MAGI is also used to determine eligibility for certain tax benefits and government-subsidized programs. Common examples include the child tax credit, adoption credit, the American Opportunity and Lifetime Learning credits for education expenses, the health insurance premium tax credit, and Medicaid coverage based on income.
In general, having lower MAGI means having a better chance of qualifying for tax benefits and programs. There are different definitions and calculations of MAGI depending on what it's used for, so it's important to apply the correct definition of MAGI to the particular benefit claimed. In addition, the cap on MAGI for certain tax deductions can change each year.
How is it 'modified'?
MAGI isn't on the tax return but is calculated based on amounts that do appear on the tax return. The starting point for calculating MAGI is adjusted gross income (AGI). From there, certain deductions are added back. If a taxpayer doesn't have any of those deductions, it's possible for AGI and MAGI to be the same. But if qualified deductions exist, MAGI will be greater than AGI.
Important tax return definitions
Gross income includes income from all sources, including cash, property, and services received. It's included on Form 1040, U.S. Individual Income Tax Return, on line 9 and labeled total income. For businesses, gross income is the same as gross profit, or revenue less cost of sales.
AGI is gross income less certain adjustments known as “above-the-line adjustments" because they reduce gross income before any other deductions, such as standard or itemized deductions. AGI is important for determining eligibility for certain tax deductions and tax credits and determines what tax bracket a taxpayer is in. It's included on line 11 of Form 1040.
The total adjustments to income are included on line 10 of Form 1040 and come from Part II of Schedule 1, Additional Income and Adjustments to Income. They include contributions to IRAs and self-employed retirement plans, self-employed health insurance premiums, self-employment taxes paid, health savings account contributions, student loan interest, educator expenses, and certain moving expenses and alimony payments, among others.
How is MAGI calculated?
To determine MAGI, once AGI is determined, additional adjustments are made to add back certain deductions and tax-exempt income. Some common adjustments are IRA contributions, half of self-employment taxes, tax-deductible student loan interest, passive income or losses, rental losses, non-taxable Social Security benefits, and excluded foreign-source income, among others.
There are many reasons MAGI is important in filing accurate tax returns and qualifying for tax credits and other benefits. Although the calculations can be confusing, it's important to understand the situations when MAGI is used and the resources and instructions available from the IRS and government agencies that can help.