Adjusted Gross Income and Modified Adjusted Gross Income
Published 4/2/08 (Modified 3/8/11)
In the world of taxes and financial planning, the terms adjusted gross income (AGI) and modified adjusted gross income (modified AGI or MAGI) are particularly significant. They are frequently used to calculate and determine the extent of certain benefits and deductions. AGI in particular is used to determine qualification to take certain itemized deductions and used to calculate taxable income. It is also the key determinative factor to rebate payment under the 2008 economic stimulus tax package. Qualification for the stimulus payment is not based on salary or after-tax take home income, but rather on the taxpayer's total adjusted gross income, which is a terminology encompassing a broader range of income sources.
The term modified adjusted gross income is particularly important as well. It is used to determine qualification to take certain tax adjustments like the child tax credit and eligibility for certain education expense credits. Overwhelmingly though, the MAGI's significance is most commonly associated with tax deferred investment retirement accounts (IRA's). It is a key income factor in determining Roth IRA contribution limits and phaseouts, as well as qualification for IRA to Roth conversions. The higher the MAGI, the more the Roth IRA contribution limit is reduced and ultimately phased out. The MAGI term is often overlooked because the amount calculated in MAGI is often similar or even the same as the adjusted gross income for most ordinary tax situations.
For clarification, here are the income and deductions that comprise both the AGI and the MAGI:
1) Adjusted Gross Income (AGI) - is comprised of all gross income sources reduced by adjustment deductions. This total income amount represents the amount before you take your personal exemption, or choice of standard or itemized deductions into account. Thus standard and itemized deductions are not factored into the AGI. The adjusted gross income is also the delineating and final number on the first page of the 1040 federal tax form that separates above-the-line adjustments such as business deductions, from below-the-line itemizations such as the charitable deduction.
The following income sources added together comprise a taxpayer's initial gross income figure:
- Salary and wage income,
- Interest income,
- Dividend income,
- Income from certain retirement accounts,
- Capital gains,
- Alimony received,
- Rental income,
- Royalty income,
- Farm income,
- Unemployment compensation.
To reach the adjusted gross income, the above total gross income amount must subtract the following deductions below:
- Deduction for contribution to an IRA,
- Health savings account deductions,
- Student loan interest deduction,
- Certain business expenses of reservists, performing artists, and fee basis government officials,
- Certain moving expenses,
- One half of self employment tax,
- Penalties on early withdrawal of savings,
- Alimony paid,
- Health insurance premiums due to self employment.
2) Modified Adjusted Gross Income (MAGI) - is basically the AGI figure, modified for various tax adjustments by excluding the items listed below. When the original AGI was calculated, certain deductions were subtracted from it. To arrive at the MAGI amount, take the AGI and add the following items back to it:
- Any deduction you claimed for a normal contribution to a Traditional IRA.
- Any deduction you claim for student loan interest or qualified tuition and related expenses.
- Any income you excluded because of the foreign earned income exclusion.
- Any exclusion or deduction you claimed for foreign housing.
- Any interest income from series EE bonds that you were able to exclude because you paid qualified higher education expenses.
- Any employer-paid adoption expense you excluded.
- Any amount claimed as domestic production activities deduction.
Tax Planning Tip For Lowering Your Modified Adjusted Gross Income (Useful for avoiding the Roth contribution limit and phaseout).
While many deductions are added back to the AGI to reach the MAGI amount, you should note that contributions made to an employer sponsored retirement plan such as a 401K is not one of them. If you anticipate reaching the annual income limit for Roth contribution phase out, you may want to seriously consider increasing your contributions to your employer's sponsored plan. For example, in 2008 you may only make contributions to a Roth IRA if your MAGI is below $169,000 if you're married filing jointly or below $116,000 if you're a single filer. The amount you may contribute to a Roth starts to phase down once your MAGI reaches $159,000 as a joint filer or $101,000 as a single filer. If you anticipate reaching the phase out period and you're on the fence, contributing some extra money into your job's 401K plan will help reduce your overall AGI as well as your MAGI, since the contribution's not one of the many items added back to calculate the MAGI.