The modified adjusted gross income is used by the IRS to find out whether a private taxpayer is eligible for specific tax deductions. The IRS most importantly use it to determine how much of an individual’s IRA contribution is deductible and whether a person qualifies for premium tax credits. An individual will be able to determine MAGI by taking adjusted gross income and adding back various items including foreign income, deductions for foreign housing, deductions for student-loans, deductions for IRA-contribution, and deductions for higher-education costs.
Differentiating Modified Adjusted Gross Income vs. Adjusted Gross Income
The size of your tax bill will be affected by your modified adjusted gross income (MAGI). Your Adjusted Gross Income (AGI) and MAGI are used for the purpose of determining which deductions and credits you qualify for. However, the IRS typically checks your MAGI if your AGI doesn't show a complete and accurate representation of your situation financially.
There’s a bit similarity between an individual’s AGI and MAGI. They can also be the same sometimes. However, it’s important to pay close attention to what you have to include your MAGI. You won’t be eligible for tax breaks like the deduction for IRA contributions if your MAGI is too high.
Understanding Modified Adjusted Gross Income
A higher MAGI means the taxpayer can take only take fewer deductions on IRA contributions. IRA deductions can even reach to zero if the MAGI is too high. In this case, the taxpayer can still contribute to an IRA plan but any contributions cannot be deducted on the following year’s taxes.
It’s typical for an individual’s MAGI to be similar to the same to his AGI. However, there may be slight differences that has a great impact on the tax return of the individual. The person can only be eligible for certain benefits depending on these differences as stated by the Affordable Care Act.
How MAGI is Calculated
In calculating MAGI, the gross income must first be calculated by a taxpayer. Gross income is composed of an individual’s total income earned through wages, interest, dividends, rental and royalty income, capital gains, business income, and any other means. Once the GI is calculated, an individual then adjusts that income by taking away qualified deductions from GI, deriving AGI. The front page of tax form 1040 will display the allowable deductions.
These deductions involve standard adjustments like retirement plan contributions, student loan interest, tuition, self-employed health insurance payments, and others. One’s AGI is necessary since it’s calculated before itemized or standard deductions, exemptions and credits are considered. It will decide how an individual can apply for certain tax credits and exemptions. For example, AGI affects the amount of money that a taxpayer can claim for the dependent care credit and the child tax credit.
When AGI is finalized, a taxpayer can then calculate MGI. Calculating MAGI is done by adding back certain deductions to AGI by the taxpayer, many of which are unusual and not realized by individuals. This means it’s fairly uncommon for an individual’s MAGI to be different in the majority from AGI. According to the IRS, the deductions added back to calculate MAGI are things like student loan interest, tuition, rental loss, and IRA contributions. The use of premium tax credits and retirement plans depends on the MAGI. For example, a taxpayer can only be eligible for a premium tax credit if his or her MAGI is less than 400% of the federal poverty line for their family size.
Bottomline
You really have no choice but to deal with your modified adjusted gross income because your tax liability can be affected by it. The federal government uses MAGI to come to a conclusion on whether you qualify for certain tax breaks or not. It most cases, it may provide a better view of your financial status than your adjusted gross income. If you want to find out to know more about the impact of your MAGI to the number of tax deductions and credits you can claim, it’s best to consult a tax professional who is experienced in this field.
Here’s a quick example to better explain MAGI. Let’s say as of 2018, you were a single filer and is under a retirement plan at work, you will not be eligible to take an IRA deduction if you had a MAGI of $73,000 or higher. Furthermore, you won’t be able to take a deduction for student loan interest if you had a MAGI of $73,000 or higher. You also couldn’t take a deduction for student loan interest if you had a MAGI of $80,000 or higher as a single individual or $165,000 if you’re married and filing jointly.
