What is Modified Adjusted Gross Income (MAGI)? - Tax Professionals Member Article By Pat Raskob
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What is Modified Adjusted Gross Income (MAGI)?

What is Modified Adjusted Gross Income (MAGI)?

How the Internal Revenue Service defines and calculates different types of income affects the taxes you owe. Modified adjusted gross income (MAGI) is one of them. MAGI also decides eligibility for specific tax benefits and government-subsidized programs.

There are various types of income for tax purposes. How the IRS defines them and how taxpayers calculate them affects how much tax they will pay. Modified Adjusted Gross Profit (MAGI) is one of them.


What is MAGI (Modified Adjusted Gross Income)?

MAGI is the amount taxpayers use to determine if they qualify for certain tax deductions, including 401(k) contributions, traditional IRA contributions and the Roth IRA, and interest on student loans.

MAGI is also used to determine qualifications for certain tax advantages and government-subsidized programs. Common instances include the adoption credit, child tax credit (CTC), American Opportunity and Lifetime Learning credits for educational expenses, health insurance premium tax credit, and Medicaid coverage based on income.

A lower MAGI means you are more likely to qualify for tax programs and benefits. Depending on the use, there are different definitions and calculations of MAGI, so it is important to apply the right one to the specific benefit needed. Additionally, the MAGI limit for certain tax deductions may change each year.


How is it "Modified"?

MAGI is not included in the tax return but is calculated based on the values declared in the tax return. The starting point for calculating MAGI is the adjusted gross income (AGI). From there, some deductions are added. AGI and MAGI may be the same if a taxpayer has none of these deductions. But if there are eligible deductions, MAGI will be superior to AGI.


Important Tax Return Definitions

Gross income is made up of revenue from all sources, including cash, goods, and services. It is included on Form 1040, US Individual Income Tax Return, on line 9 and is labeled as Total Income. For businesses, gross income equals gross profit or revenue minus the cost of goods sold.

AGI is gross income less specific adjustments known as "above the line adjustments" because it reduces gross income before other deductions, such as itemized or standard deductions. The AGI is important in determining eligibility for certain tax deductions and credits and determines which tax category a taxpayer falls into. It is included on line 11 of Form 1040.

The total income adjustments are included on line 10 of Form 1040 and are taken from Part II of Schedule 1. These include contributions to self-employed retirement plans and IRAs, self-paid health insurance premiums, self-paid taxes, contributions to health savings accounts, student loan interest, school fees, education, and certain moving expenses, as well as alimony, among others.


How MAGI affects tax deductions and credits

In addition to being important in determining Roth IRA contribution eligibility in the deductibility of Traditional IRA contributions, MAGI is used to determine eligibility for various tax credits and deductions, including:

  • Child Tax Credit (CTC): Parents can get a tax credit of up to $2,000 for each eligible child under age 17. Some of them are also refundable under any circumstances, which may allow you to receive a refund even if you don't owe taxes. MAGI-based income is phasing out for those earning over $200,000 ($400,000 when married).

  • Education credits: You can get a tax credit for tuition fees and related expenses. However, there is a phasing out of MAGI-based income.

  • Premium Tax Credit: This tax credit is designed to help cover health insurance premiums purchased in the health insurance market by low-to-moderate income individuals and families.

  • Tax on net investment income: net investment income comes from interest, dividends, certain income, rent, and royalties. Also, it is considered net investment income if you earned it through passive activity, such as selling goods or trading financial instruments (think stocks, bonds, mutual funds, investment, etc.) or commodities (such as oil). It is taxed at a rate of 3.8% of net investment income or 3.8% of MAGI above certain limits, whichever is lower.


How to Calculate Modified Adjusted Gross Income

Because it's a rule of thumb that taxes have to be complicated, you won't find your MAGI anywhere on your tax return. It must be calculated. It is a three-step process:

Step 1: Find your gross annual income.

The IRS defines gross income as income service income, including taxes, fees, benefits, and other similar items. Gross profit is any taxable profit before tax. 

Your gross annual income includes your workplace or business salary and the following. The sum of all these things will give you the gross annual income.

  • Capital Gain: If you make money from the sale of a house, property, or investment, among other things, you will have a capital gain on which you will have to pay taxes.

  • Tax on Retirement Benefits: This includes taxable amounts for all IRA distributions, pensions and annuities, and Social Security benefits.

  • Taxable Dividend Income: If you owe tax on investment dividend payments, you will receive a 1099-DIV

  • Taxable interest: this may be interest on money in the bank. You can get a 1099-INT if you have to pay this interest.

  • Other Income: This broad category includes any income you get from something else. It includes things like alimony and income tax. It can be found in Schedule 1, line 9.

Step 2: Find your AGI

AGI is Adjusted Gross Income. This is the gross income minus some adjustments. It is important because it is the income on which taxes are based.

Your adjusted gross income (AGI) can be found on line 8b of the 1040 tax return. You can also calculate it by subtracting the different categories of deductions listed in Schedule 1, the total of which will be reported on line 22 of the form. Here is a list of categories that can be deducted from the total gross income in calculating the AGI.

  • Alimony: Alimony paid to a former spouse under a divorce agreement is tax-deductible.

  • Early Withdrawal of Savings Penalties: In eligible situations, you may deduct taxes on early retirement withdrawal from your savings accounts. The penalty would be on Form 1099-INT.

  • Educator expenses: If you are an eligible educator, you may be able to deduct certain expenses if you get things for the class and your students that are used during teaching.

  • Health Savings Account: If you are in a highly deductible health plan and have a Health Savings Account, you can deduct your AGI plan contributions. These are on Form 8889.

  • IRA Deduction: Depending on your eligibility, you may be able to deduct contributions to a traditional IRA. Remember that Roth IRA contributions are not tax-deductible.

  • Military Moving Expenses: Military members may deduct relocation expenses when they receive a permanent change of station. This is form 3903.

  • Qualified business expenses in various fields: If you are in the military reserve, a performing artist, or a government employee, you may be able to deduct some of the expenses listed on Form 2106.

  • Self-Employed Health Insurance Deduction: If you paid health insurance premiums for yourself or your family as a self-employed individual, this deduction is for you.

  • Self-employment tax deduction: You may be eligible to deduct part of your self-employment tax. This is available on Schedule SE.

  • SEP, SIMPLE, and other qualified pension contributions: This is designed to allow employees of small businesses or self-employed employees to deduct pension contributions.

  • Student loan interest deduction: For those paying qualifying student loans, you can deduct less than $2,500 or the amount of interest paid during the fiscal year. This gradually decreases and eventually phases out depending on your MAGI level.

Step 3: Add some deductions to find your MAGI

To calculate your MAGI and determine if you are entitled to certain deductions and credits, you must add up certain deductions you made when calculating the AGI.

  • Add deductions taken for IRA contributions and taxable Social Security payments

  • Adoption expenses exclusion

  • Eligible Tuition expenses 

  • Excluding income from abroad

  • Half your self-employment taxes

  • Interest on EE savings bonds used to pay for post-secondary education

  • Interest on student loans or tuition deductions

  • Passive Income losses (including rent)

  • Publicly traded partnership losses

It is common for your MAGI to align very closely with your AGI.


Summary

Your modified adjusted gross income is essential in determining your eligibility for multiple tax credits and deductions. In addition to deciding whether you are eligible to contribute to a Roth IRA, your MAGI also determines whether you can deduct contributions for a traditional IRA.

In addition to retirement implications, MAGI also affects eligibility for health insurance premiums, education, and child tax credits. It also determines how much you pay for certain taxes, like the new investment tax. Your MAGI will not appear on your tax return, but it can be calculated if you first calculate your gross income and your AGI.

As always, taxes are complicated. If you have any questions about your finances or tax status, we recommend you speak to a financial advisor or tax specialist.


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Pat Raskob
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