Modified adjusted gross income (MAGI): How to calculate MAGI

Key takeaways

• Modified adjusted gross income (MAGI) is adjusted gross income (AGI) after you’ve added specific deductions and exclusions back in.
• The IRS uses MAGI to determine your eligibility for specific tax benefits, such as education credits, retirement contributions, the Premium Tax Credit (PTC), and the Child Tax Credit (CTC).
• Your MAGI affects whether your contributions to retirement accounts are deductible, and how much you can contribute to a Roth IRA.
• The IRS uses your MAGI to determine your eligibility for education-related tax credits, like the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC), which can provide significant savings.
• The PTC helps individuals and families afford health insurance when they buy through the Health Insurance Marketplace. Whether you qualify for this credit depends on your MAGI and a few other factors.
• The CTC provides financial relief for families with qualifying children. Your MAGI affects whether you can claim the full credit, a reduced credit, or no credit at all.
• The IRS uses both AGI and MAGI in determining your eligibility for various tax benefits, but they are calculated differently and serve different purposes.
• There are several ways to lower your MAGI, which can help you qualify for more tax benefits and reduce your tax.

What is modified adjusted gross income (MAGI)?

It’s important to understand your modified adjusted gross income (MAGI) to navigate various tax benefits and limits. But before we dive into what MAGI is, it's helpful to first understand adjusted gross income (AGI).

AGI is your total gross income for the year, minus specific deductions. It includes all the income you receive, such as wages, interest, dividends, business income, and capital gains, but it allows for certain adjustments. These adjustments can include contributions you’ve made to your retirement accounts and student loan interest you’ve paid, among others. Your AGI is a key figure that the IRS uses to determine your taxable income and eligibility for various tax credits and deductions.

MAGI takes your AGI and adjusts it further by adding certain deductions and exclusions back into the final figure. The IRS uses your MAGI to determine your eligibility for specific tax benefits, such as education credits, retirement contributions, and health insurance subsidies.

While the term might sound complex, it essentially boils down to a figure that influences your ability to qualify for different tax breaks. Knowing your MAGI can help you plan more effectively and take advantage of potential savings when you file your tax return.

What is MAGI used for?

The IRS uses your MAGI to determine your eligibility for various tax benefits and programs, including:

• Tax credits and deductions: MAGI helps the IRS establish whether you qualify for certain tax credits and deductions that can reduce your tax and lower your taxable income.
• Retirement contributions: Your MAGI determines how much you can contribute to certain retirement accounts, and whether you can deduct your retirement contributions. Depending on your MAGI, you might be able to reduce your taxable income by contributing to these accounts.
• Healthcare benefits: The IRS uses your MAGI to determine your eligibility for healthcare-related benefits.
• Income-based surcharges: For higher-income earners, the IRS uses MAGI to assess additional taxes and surcharges. For example, it can determine whether you owe the additional Medicare tax, which only applies to those with incomes above certain thresholds.
• Education and adoption benefits: Your MAGI affects your eligibility for educational tax benefits and adoption credits, which can provide significant financial assistance for families.
• Loan interest deductions: If you are paying off student loans, your MAGI determines whether you can deduct the interest you’ve paid on these loans, offering potential tax relief.
• Clean vehicle credit: Your MAGI may qualify you for a credit for purchasing an environmentally friendly new or pre-owned car.

Eligibility for tax credits and deductions

Here are some of the key tax credits and deductions where the IRS relies on MAGI to determine eligibility.

Retirement contributions

Your MAGI affects whether your contributions to employee-sponsored retirement accounts, such as traditional IRAs, are deductible, and whether you can contribute to a Roth IRA the maximum amount, a partial amount, or nothing at all.

Traditional IRA contributions

If your MAGI is below a certain threshold, you can deduct your full IRA contribution. If your MAGI is within the phase-out range, you can deduct only a portion of your contribution. Above the phase-out range, you cannot deduct any of your contribution.

Roth IRA contributions

Your MAGI also determines if you’re eligible to contribute to a Roth IRA, and how much you can contribute. If your MAGI falls within the phase-out range, you can only contribute a portion of the maximum Roth IRA contribution. If your MAGI is greater than a certain limit, you may not be able to contribute to a Roth IRA at all.

Education credits

The IRS uses MAGI to determine eligibility for education-related tax credits that can provide significant savings.

American Opportunity Tax Credit (AOTC)

This credit helps cover the cost of tuition, fees, and course materials for the first four years of college. There are MAGI limits that determine whether you can claim the full credit, a reduced amount, or none at all.

Lifetime Learning Credit (LLC)

This credit is available for tuition and related expenses for undergraduate, graduate, and professional degree courses. Like the AOTC, your MAGI must be below a certain level to qualify for the full credit.

Premium Tax Credit

The Premium Tax Credit (PTC) helps individuals and families afford health insurance when they buy through the Health Insurance Marketplace by lowering monthly premiums. Whether you qualify for this credit depends on your MAGI and a few other factors.

To be eligible for the PTC, your MAGI must be between 100% and 400% of the federal poverty line for your family size. If your income falls within this range, you may qualify for the credit.

The amount of credit you receive is based on your MAGI, the number of people in your household, and the cost of health insurance in your area. The credit ensures that you spend only a certain percentage of your income on premiums, making health insurance more affordable.

Child Tax Credit

The Child Tax Credit (CTC) provides financial relief for families with qualifying children. Your MAGI affects whether you can claim the full credit, a reduced amount, or none of the credit. The credit begins to phase out at higher income levels, so knowing your MAGI can help you determine your eligibility and plan accordingly.

How to calculate MAGI

Calculating your MAGI is an important step in determining your eligibility for various tax benefits. Here’s a step-by-step guide to help you understand how to calculate MAGI.

1. Calculate your AGI

   Your AGI is the starting point for calculating your MAGI. AGI includes all the income you received throughout the year, such as wages, dividends, capital gains, business income, and other earnings, minus specific deductions, like contributions to retirement accounts and  student loan interest.

2. Add back specific deductions

   Once you have your AGI, the next step is to add back certain deductions and exclusions that you subtracted from your total income to arrive at your AGI. These items vary, depending on the specific tax credit or deduction in question.

Common additions include

• Tax-exempt interest income: This is interest earned on bonds or other investments that are not subject to federal income tax.
• Foreign earned income and housing exclusion: If you excluded income you’ve earned abroad, you need to add it back to your AGI.
• Deductions for IRA contributions: Add back any contributions you’ve made to traditional IRAs that you deducted.
• Student loan interest deduction: If you deducted interest paid on student loans, add it back in.

Adjust for additional items

Depending on the specific tax benefit you’re interested in, there may be additional items to consider. It's important to check the requirements for each credit or deduction to ensure you include all necessary adjustments. For instance, for the PTC, your MAGI may also include non-taxable Social Security benefits.

Here’s an example:

Let’s say your AGI is $50,000, and these are the adjustments you’ve made: $1,000 in tax-exempt interest, $2,000 in foreign earned income, and $3,000 in deducted IRA contributions.

Here’s how you would calculate your MAGI:

$50,000 (AGI) + $1,000 (tax-exempt interest) + $2,000 (foreign income) + $3,000 (IRA contributions) = $56,000

What is the difference between AGI and MAGI?

Understanding the difference between AGI and MAGI is important for managing your taxes effectively. The IRS uses both in determining your eligibility for various tax benefits, but you calculate them differently and they serve different purposes.

Here are the key differences between AGI and MAGI

• Scope of income: AGI includes your total income minus specific deductions, while MAGI is AGI adjusted to include certain additional income sources and deductions.
• Purpose: AGI is used to determine your taxable income and eligibility for basic deductions and credits. MAGI, on the other hand, is used to assess eligibility for specific tax benefits, like education credits, retirement contribution deductions, and health insurance subsidies.
• Calculation variations: The adjustments made to AGI to arrive at MAGI can vary depending on the tax benefit in question. That means you may need to calculate your MAGI in a different way for different tax credits and deductions.

Are capital gains included in MAGI?

Yes, capital gains are included in MAGI. Capital gains are the profits you earn from selling assets like stocks, bonds, real estate, and other investments. These gains contribute to your overall income and can significantly impact your MAGI, which in turn, affects your eligibility for various tax benefits.

Capital gains are classified into two types

• Short-term capital gains: These are gains from assets you’ve held for one year or less. They are taxed at your ordinary income tax rates.
• Long-term capital gains: These are gains from assets you’ve held for more than a year. They are taxed at reduced rates, which are generally lower than ordinary income tax rates.

Since MAGI is derived from your AGI, and AGI includes all forms of income, capital gains are naturally part of your MAGI calculation.

How to lower your MAGI

Lowering your MAGI can help you qualify for more tax benefits and reduce the tax you owe. Luckily, there are several strategies to help you lower your MAGI effectively.

• Contribute to retirement accounts: One of the most effective ways to lower your MAGI is by contributing to retirement accounts. You can deduct contributions you’ve made to traditional IRAs, 401(k)s, and other retirement plans from your gross income, which can reduce your AGI and subsequently your MAGI.
• Take advantage of Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs): When you contribute to HSAs and FSAs, your taxable income is reduced, as is your MAGI.
• Claim above-the-line deductions: You can claim certain above-the-line deductions (deductions taken out before calculating your AGI) without itemizing, such as student loan interest and self-employment expenses.
• Manage capital gains and losses: Strategically selling investments can help you manage your MAGI. If you have capital gains, consider selling investments at a loss to offset these gains. This practice, known as tax-loss harvesting, can help reduce your taxable income.

Understanding MAGI is essential for maximizing your tax benefits and ensuring you qualify for valuable credits and deductions. By knowing what MAGI is, how it differs from AGI, and how it affects your eligibility for various tax benefits, you can make informed financial decisions.

Managing your MAGI effectively can lead to significant tax savings. However, tax laws can be complex, and individual situations vary. For personalized advice and to ensure you are making the most of your tax situation, consider working with a Tax Pro. A Jackson Hewitt Tax Pro can provide tailored guidance and help to ensure you get every dollar you deserve.