When it comes to your income, the IRS has some unique ways of calculating what you and the members of your household earn beyond just simply adding up your paychecks.
In this article, we’ll cover two specific types of income: adjusted gross income and modified adjusted gross income. Understanding these will give you a better idea on how the IRS determines your eligibility for certain deductions, credits, and retirement plans.
What is adjusted gross income (AGI)?
We’ll start with your adjusted gross income (AGI). Simply put, your AGI is your gross income minus any adjustments to your income.
Let’s break that down, starting with your gross income—this is the money you earn or have coming into your household.
Your gross income can come from a lot of places, including:
- Rental and royalty income
- Capital gains
- Business income
- Farm income
- Retirement distributions
Next, let’s talk about what kinds of things can “adjust” your gross income.
Adjustments to your gross income can come from the following places:
- Contributions to a retirement account
- Moving expenses
- Alimony paid
- Self-employment taxes
- Educator expenses
- Student loan interest
How to calculate your adjusted gross income (AGI)
Now that you understand the pieces that make up your AGI, let’s try calculating it. Remember: the formula for calculating your AGI is gross income minus any adjustments.
Say your friend Josie earns a salary of $60,000 a year—that’s her gross income. She also contributes $300 a month to her IRA, so $3,600 a year—that’s an adjustment to her gross income.
Here’s how you calculate Josie’s AGI: Take her gross income of $60,000 minus her adjustments of $3,600 and you get an AGI of $56,400. Easy peasy!
Of course, you’ll likely have a more complicated list of income and adjustments, but there’s no need to do the math on your own. There are plenty of online AGI calculators out there to make your life that much easier, like this one from CNN Money. Line 11 of your 1040 form also lists your AGI.
Why your AGI matters
Your AGI represents your total taxable income before itemized or standard deductions, exemptions, and credits are taken into account. That income directly influences which deductions and credits you’ll be able to claim on your tax return.
Generally speaking, you want your AGI to be low. The lower your AGI is, the more deductions and credits you’ll be eligible to receive.
What is modified adjusted gross income (MAGI)?
Now that you’ve got a handle on AGI, let’s cover modified adjusted gross income (MAGI). Your MAGI is the total of your household’s AGI plus any tax-exempt interest income you may have.
A few examples of tax-exempt interest income include:
- Any deductions you took for IRA contributions and taxable Social Security payments
- Any amount excluded from your gross income
- This includes foreign earned income and housing costs for qualified individuals
- Any amount of interest received or accrued by the taxpayer during the taxable year which is exempt from tax
- This could include interest from EE savings bonds used to pay for higher education expenses
- Losses from a partnership
- Passive income or loss
- Rental losses
- The exclusion for adoption expenses
If you’re looking at your 1040 form, you’ll find these amounts on lines 37 and 8b. However, these items are pretty uncommon, so it’s very likely that your AGI and MAGI will turn out to be the same.
How to calculate your modified adjusted gross income (MAGI)
Once you have your adjusted gross income, you simply "modify" it by adding any tax-exempt interest income to calculate your MAGI. But again, you probably won’t have any tax-exempt interest income to add, so calculating your MAGI can be as easy as taking your AGI and adding zero.
Why your MAGI matters
The IRS phases out credits and deductions as your income increases. By adding MAGI factors back to your AGI, the IRS determines how much you really earned. Based on that, it determines whether you can take full advantage of special tax credits.
Here are just a few things the IRS can determine based on your MAGI:
- If, and how much, you can contribute to a Roth IRA
- If you can deduct your traditional IRA contributions from your spouse’s or your own employer-provided retirement plan
- Your eligibility for the premium tax credit, which lowers your health insurance premiums if you buy a plan on the health insurance marketplace
- Revisions to the Affordable Care Act have made it so no one will pay more than 8.5% of their MAGI for health care purchased through the exchanges through 2022
While these incomes may take a minute to calculate, they serve as an important tool in helping you determine what kinds of tax deductions and credits you can expect on your next return, as well as deciding how much you’ll pay for health insurance premiums. The more you understand about how the IRS categorizes your household income, the more prepared you’ll be for tax season and the credits that could be coming your way.
This article was originally published on January 24, 2013. It was last updated March 10, 2021.