What is Modified Adjusted Gross Income (MAGI)?

While most people focus on gross or taxable income when it comes to taxes, another figure deserves a bit more attention as well: modified adjusted gross income (MAGI). So, what exactly is this, how does it differ from adjusted gross income (AGI), and why should you care about MAGI even if you're not a tax professional? Keep reading to learn more!

What is modified adjusted gross income (MAGI)?

In its simplest form, modified adjusted gross income is essentially your adjusted gross income (AGI) with certain deductions added back in. The IRS uses this to determine your eligibility for various tax benefits including making contributions to a Roth IRA, deducting traditional IRA contributions, and making student loan interest deductions.

How to calculate your MAGI

Calculating your modified adjusted gross income (MAGI) isn’t as tricky as it sounds—just follow these simple steps:

Step 1: Determine your gross income

You’ll first need to calculate your gross income, which includes wages plus other sources of income such as earnings from rental properties, interest income, unemployment benefits, and stock dividends.

Step 2: Make deductions to calculate your AGI

After calculating your gross income, subtract above-the-line deductions to arrive at your adjusted gross income (AGI). These deductions may include retirement account contributions, student loan interest payments, and health savings account (HSA) contributions, and you’ll find your AGI on Line 11 of IRS Form 1040.

Step 3: Add back certain adjustments

The IRS requires you to add back specific items to your AGI to determine your MAGI. These may include:

• IRA contributions

• Tax-exempt interest income (such as interest from municipal bonds)

• Non-taxable Social Security payments

• Qualified tuition expenses

• Rental losses and passive income adjustments (in some cases)

The final figure you come up with after adding back those necessary amounts is your MAGI.

MAGI vs. AGI: What’s the difference?

Both MAGI and AGI are important tax figures but serve different purposes, as outlined in the following table:

Understanding AGI and MAGI distinctions is crucial for effective tax planning given:

• Tax benefit eligibility: Those whose MAGI exceeds a certain threshold may not qualify for Roth IRA contributions, health insurance subsidies, or education tax credits.

• Taxable income impacts: AGI influences how much of your income is subject to taxation; a lower AGI results in less taxable income, thus perhaps reducing your overall tax bill.

• Deductions and MAGI: Some deductions (e.g., traditional IRAs) are discontinued based on your MAGI; as many tax breaks begin to phase out as this number rises, understanding how to lower your MAGI (legally, of course) is beneficial for tax planning.

You can create a more effective tax strategy by keeping all of these factors in mind.

How the IRS uses AGI

The IRS uses your MAGI and AGI for different purposes. With respect to AGI, specifically, this serves as the foundation of your tax return and helps the IRS calculate taxable income, establish limits on some deductions, and determine tax brackets. It’s also used to assess eligibility for some credits such as the Earned Income Tax Credit (which has AGI-based income limits).

How the IRS uses MAGI

Conversely, IRS MAGI rules are used to determine eligibility for specific tax breaks. Here's how this applies to various scenarios:

• IRA contribution limits: A MAGI too high may disqualify you from contributing to a Roth IRA and/or limit your ability to deduct traditional IRA contributions.

• Affordable Care Act (ACA) subsidies: Your MAGI determines your eligibility for health insurance premium tax credits under the ACA, meaning you can lose access to these benefits if it’s too high.

• Student loan interest deductions: A MAGI exceeding the specified income threshold can disqualify you from deducting interest paid on student loans.

• Child Tax Credit: As the IRS sets income limits dictating eligibility for this valuable tax break for parents, a MAGI too high can in turn reduce the credit.

• Medicare premium costs: Your MAGI influences your Medicare Part B and Part D premiums (if applicable); the higher your MAGI, the more you may have to pay in income-related monthly adjustment amounts and (thus) for healthcare in general.

• Passive activity loss rules: If you own rental properties or have passive business income, MAGI plays a significant role in determining whether you can claim losses or deductions; a higher MAGI can limit your ability to offset rental property losses, ultimately impacting your overall tax liability.

Many federal and state assistance programs also use MAGI to determine eligibility, with a higher number sometimes leading to:

• Less financial aid for college students: A higher MAGI may stifle eligibility for grants, subsidized loans, and work-study programs.

• Reduced eligibility for need-based benefits: Programs such as Medicaid, the Supplemental Nutrition Assistance Program (SNAP), and housing assistance utilize MAGI to assess financial need; those with a MAGI exceeding program limits can lose access to these benefits.

• Social Security taxation impacts: A high MAGI can result in up to 85% of your Social Security benefits becoming taxable, thus reducing the amount of money you can keep in retirement.

Conclusion: understanding MAGI

Understanding your modified adjusted gross income (MAGI) can significantly improve your financial situation as this number plays a huge role in determining eligibility for tax deductions, credits, and other programs. You’ll thus want to keep track of where you stand in this respect to help maximize your savings and avoid any unexpected tax issues.

Have questions related to MAGI or other tax-centric matters? Schedule a FREE discovery call with one of our CFP® professionals so we can help!

FAQs

• Does MAGI affect my taxes?

  Yes, MAGI determines your eligibility for some tax benefits such as contributing to a Roth IRA, qualifying for premium health insurance tax credits, and deducting interest on your student loans; you may miss out on these advantages if your MAGI is too high.

• Can MAGI change from year to year?

  Yes, it can. Pay raises, investment income, and/or new tax deductions can all affect your MAGI and thus potentially alter your tax benefit eligibility.

• What are my options if my MAGI disqualifies me from tax benefits?

  You can reduce your MAGI by contributing to pre-tax retirement accounts such as a 401(k), health savings account (HSA), or flexible spending account (FSA): contributions that lower your taxable income and in turn decrease your MAGI.

• Can I estimate my MAGI without filing my taxes?

  Yes, you can do so by starting with last year’s adjusted gross income (AGI) and adding back any tax-exempt income, foreign income exclusions, and/or untaxed Social Security benefits (ideally enlisting the help of tax software or a professional for assistance).

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Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.