The Internal Revenue Service (IRS) uses the Modified Adjusted Gross Income (MAGI) as a measure to determine whether a taxpayer qualifies for certain contributions or deductions to a Roth IRA (Individual Retirement Account).
MAGI also determines if a taxpayer qualifies for certain income tax credits and education tax benefits. In simple terms, it denotes your Adjusted Gross Income (AGI) – including a few items like excluded income plus certain deductions.
MAGI = Adjusted Gross Income + Qualifying Tax Deductions
Understanding MAGI (Modified Adjusted Gross Income)
When calculating MAGI, it is important to know that AGI and MAGI are different concepts. AGI is calculated by getting the annual income less several deductible expenses. AGI takes into account certain income items like a rental home, wages, farm income, retirement income, and business income.
The total annual income is adjusted via deducting tax-deductible expenses like student loan interest, retirement plan contributions, health insurance expenses, health savings account, IRA deductions, and penalties on premature withdrawal of savings and education expenses.
To determine whether the taxpayer qualifies for tax deductions and tax credits, the IRS uses the AGI as a reference point when doing tax calculations.
MAGI is determined by taking the Adjusted Gross Income (AGI) and adding these deductions:
- Rental losses
- Excluded foreign income
- The deductions for IRA contributions
- Passive losses or income
- EE savings bonds interest
- Student loan interest deductions
- Half of the self-employment tax
The Difference Between AGI and MAGI on Your Taxes
| Difference | AGI | MAGI |
| Calculation | Add all of your annual income; then subtract any allowable adjustments like Individual Retirement Account (IRA) contributions, student loans interest, and alimony payments. You can also use 50% of self-employed health insurance premiums, self-employed taxes, and qualified tuition. | Taxpayers add some adjustments to the total AGI to figure out if they can benefit fully from tax perks. Tuition-related deductions or costs, 50% of paid self-employment tax, rental property losses, and student loan interest are adjustments that are added to arrive at MAGI. |
| Effect on Your Taxes | Influences directly your qualification for claiming many of the tax credits and tax deductions present on your tax return. The child and dependent care credit and the earned income credit – depending on the calculations of your AGI. Tax deductions like mortgage insurance premiums, total itemized deductions, and medical deduction allowances are based on your AGI. | The MAGI figure is used by the IRS to determine how much IRA contribution an individual can deduct and if an individual qualifies for premium tax credits. A high MAGI level means fewer deductions that an individual can take on IRA contributions. A very high MAGI can lead to zero IRA deductions. In cases of such a scenario, you can still make IRA plan contributions, but it will be impossible to make deductions of any contributions in the next year. |
How to Calculate MAGI
MAGI (modified adjusted gross income) is calculated differently depending on the tax benefit under evaluation and the reason for which it is being computed. The IRS does have instructions on how to calculate MAGI. Below are some examples of how MAGI is calculated.
Education Credits
This type of credit assists students with the cost of higher education by reducing the total taxes owed on a tax return. If the tax owed is reduced to less than zero by the tax credit, the taxpayer may be subjected to a tax refund. To get educational credits, MAGI is calculated by adding the adjusted gross income with housing exclusions and foreign income.
Traditional IRA Contribution Deductions
MAGI is calculated by adding adjusted gross income with the domestic production activities deduction, the housing exclusion, foreign earned income, student loan interest, excluded savings bond interest, the foreign housing deduction, certain fees, and the student loan deduction, and excluded employer adoption benefits.
Premium Tax Credit
This is a United States tax credit provided by the IRS to assist eligible households with moderate to low income in purchasing health insurance via a healthcare exchange. As a result, MAGI is calculated by adding AGI with tax-exempt interest, foreign earned income, and the tax-free part of the social security benefits.
Child Tax Credit
With the Child Tax Credit, MAGI is calculated by adding AGI with housing exclusions and foreign earned income, foreign housing deductions, excluded income from bonafide residents of American Samoa, and excluded income from Puerto Rico.
How is MAGI used?
MAGI is the primary basis used in determining a taxpayer’s qualification for tax deductions and tax credits. Here is how MAGI is used.
Buying Health Insurance
MAGI comes in handy when buying health insurance coverage via state health insurance. When determining whether an individual is eligible for health coverage, most insurance providers use MAGI as a baseline. This exchange uses MAGI to figure out how and if a customer will make savings on health insurance plans.
Roth IRA Contributions
A customer is affected directly by MAGI on how much they can pay to a Roth IRA. The taxpayers’ MAGI is considered by the IRA to determine whether it is high enough to make contributions to the Roth IRA.
Itemizing Tax Deductions
Itemized tax deductions include expenditures that can be deducted from the AGI to reduce the full tax bill. This enables taxpayers to pay lower tax bills than taking standard deductions in some cases. When filing taxes, if a taxpayer decides to itemize deductions, they may need to calculate their MAGI.
The IRS determines the instance in which particular deductions will be fully eliminated or reduced depending on the MAGI. Itemized deductions are recorded on Schedule A and Form 1040. Allowable itemized deductions examples include unreimbursed medical expenses and mortgage interest – to name a few.
Conclusion
Are you still questioning what Modified Adjusted Gross Income (MAGI) is and how to calculate it? Contact Sherry Broshoff at Borshoff Consulting. She is a tax pro and dedicated to knowing the nuts and bolts of taxes and can assist you in understanding your tax return and capitalize on available deductions and credits. You can trust Indiana’s tax expert!
