When it comes to your income, the IRS has some unique ways of calculating what you and the members of your household earn beyond simply adding up your paychecks.
The IRS allows individual taxpayers to use tax deductions and credits to reduce their tax liability based on their adjusted gross income (AGI) and modified adjusted gross income (MAGI). Together, these tools may result in slight differences that can seriously impact your federal tax return.
In this article, we’ll go into detail on how AGI and MAGI work for taxpayers. Understanding these will give you a better idea of how the IRS determines your eligibility for certain tax deductions, credits, and retirement plans. As always, if you have specific questions, reach out to your CPA or tax professional.
What is adjusted gross income (AGI)?
When you calculate your income taxes for the year, knowing your AGI is a good first place to start in determining the amount of taxes you’ll owe.
Simply put, your AGI is your gross income minus any adjustments to your income. Your AGI can sometimes be more valuable than your regular gross income for individual tax purposes. This is because your AGI is an essential, intermediate step for finding out how much of your gross amount is considered taxable income.
Let’s break down the aspects of your AGI, starting with your gross income. As you may already know, your gross income is the money you earn or have coming into your household.
There are several potential gross income sources, including:
- Social Security benefits
- Rental income
- Royal income
- Capital gains
- Business income
- Farm income
- Investment income
- Student loan payments
- Alimony payments
- Retirement income
Next, let’s talk about what kinds of things can “adjust” your gross income, which is the second part of determining your AGI.
Adjustments to income include the following items:
- Contributions to an individual retirement account
- Moving expenses
- Alimony paid
- Self-employment taxes
- Educator expenses
- Student loan interest
- Charitable contributions
How to calculate your adjusted gross income
Now that you understand the pieces that make up your AGI, let’s try calculating it. You can get your AGI by adding all the household income you earned during the year and subtracting any allowable adjustments.
If applicable, you can also deduct 50% of any self-employment taxes you paid and self-employed health insurance payments for you and your family members to reach your AGI.
Now, let’s do an example calculation. If you earn a salary of $60,000 a year, that amount is your gross income. If you also contribute $300 a month to your IRA, or $3,600 a year, that’s an adjustment to your gross income.
If you take your gross income of $60,000 minus your adjustments of $3,600, you get a calculated AGI of $56,400.
Of course, you’ll likely have a more complicated list of income and adjustments than our example, but you don’t have to do the math on your own. There are several online AGI calculators1 to help you during tax season. If you want to skip the calculations altogether, Line 11 of your 1040 form2 lists your AGI.
Why is adjusted gross income important?
Your AGI represents your total taxable income before standard or itemized deductions, exemptions, and credits are considered. That income directly influences which deductions and credits you’ll be able to claim on your tax return, determining whether you’ll have a tax bill or get a refund.
For instance, the earned-income credit (EIC) and the child and dependent care credit depend on AGI calculations. Similarly, certain tax deductions are based on your AGI. These include mortgage insurance premiums (MIPs) and medical expense deduction thresholds,
Generally speaking, if you want to be eligible for tax deductions and credits, you want your AGI to be low. Your AGI will never be more than your gross income, but 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 MAGI. For many taxpayers, MAGI is simply AGI with the student loan interest deduction added back in. But for some that have more complex tax returns, it can include more items. As such, you may consider MAGI as your AGI with specific deductions or tax exempt interest income added back in.
A few examples of items that can be included in your MAGI include:
- Any deductions you took for IRA contributions and taxable Social Security payments
- Any amount excluded from your gross income
- This includes foreign 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 Series EE savings bonds used to pay for higher education expenses
- Losses from a partnership
- Passive income or loss
- Rental losses
- Income exclusion for adoption expenses
If you’re looking at your 1040 form, you’ll find these tax-exempt interest amounts on lines 37 and 8b. However, these items are pretty uncommon, so your AGI and MAGI will likely turn out to be the same. Additionally, your total MAGI doesn't appear on your annual tax return, unlike your AGI.
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 or deductions to calculate your MAGI to determine whether you can take full advantage of tax benefits.
The IRS begins to phase out deductions for items such as IRA contributions and educational expenses at certain income levels.
Some of the most common adjustments used to arrive back at your MAGI include:
- Qualified tuition expenses or deductions
- Losses from rental properties
- Half of the self-employment tax you paid during the tax year
- Student loan interest
But again, you typically won’t have much, if any, tax-exempt interest income to add, so calculating your MAGI can be as easy as taking your AGI and adding zero.
Why is modified adjusted gross income important?
The IRS phases out credits and allowable deductions as your household income increases. By adding MAGI factors back to your AGI, the IRS determines how much you truly earned. Based on that, it determines whether you can take full advantage of tax credits.
For example, the IRS uses the MAGI figure to determine if, and how much, you can contribute to a Roth IRA3, and if you can deduct your traditional IRA contributions from your spouse’s or your own employer-provided 401K plan.
The higher the MAGI, the fewer deductions you can take on IRA contributions. If your MAGI is too high, IRA deductions may even reach zero. If this is the case, you can still contribute to an IRA plan, but can’t deduct any of the contributions.
Your MAGI also dictates whether you're eligible for any premium tax credits. If you qualify, you can use premium tax credits to help lower your premiums on a health insurance plan purchased through the individual health insurance Marketplace, Medicaid, and the Children's Health Insurance Program (CHIP).
MAGI also outlines whether you can claim certain deductions, such as student loan interest. Individuals with a MAGI under $91,000, or $182,000 for married couples filing jointly4, can claim the deduction in the 2022 tax year. Those whose MAGI exceeded that amount don't qualify.
It's normal for a person's MAGI to be similar to or the same as their AGI, but it’s always good to double-check each year. While these incomes may take a minute to calculate, they’re an important tool in helping you determine what kinds of tax deductions and credits you can expect on your next return and how much you’ll pay for health insurance premiums.
The more you understand how the IRS categorizes your annual household income, the more prepared you’ll be to fill out your federal income tax return and potentially receive any credits that could be coming your way.
This article was originally published on March 10, 2021. It was last updated on August 29, 2022.