Some tax credits are the Earned Income Tax Credit (EITC), the Child Tax Credit, and the Premium Tax Credit.
Tax credits can bring substantial savings on your federal tax bill because it reduces it dollar-for-dollar. A $500 tax credit means $500 off your tax liability, full stop.
Refundable tax credits can reduce your tax liability below zero, and the negative amount that “exceeds zero” will be given back to you as a tax refund.
Nonrefundable credits are subtracted from your tax liability, up to the total amount you owe, but cannot reduce your tax balance beyond zero.
Whether or not a tax credit is refundable, it is worth the effort to make sure you are claiming every credit that you’re eligible for.
Why adjusted gross income (AGI) is inadequate in your tax calculations for the IRS
The simplest way we can define the Modified Adjusted Gross Income (MAGI for short) is “your AGI plus a few things”. Things are far more complex than that, of course! But this short explanation is the basis on which we’ll build all our other explanations. We’ve talked at length about what AGI (Adjusted Gross Income) is and how to calculate it, now it’s time to modify it and explain what it’s used for.
The first layer of added complexity is that there is not single MAGI, since there are different definitions of it for different tax benefits and credits, as well as the amounts required to qualify for them (we told your it got complicated).
Why adjusted gross income (AGI) is inadequate in your tax calculations for the IRS
Your Modified Adjusted Gross Income (MAGI) makes you eligible for a number of tax credits, benefits, and exclusions, making it a vital part of your tax return calculations, particularly since the IRS will put your math to the test. Your MAGI is used to determine your eligibility for various Federal tax benefits — including education tax breaks, the adoption tax credit, the retirement savings contribution credit, and many more.
AGI represents your taxable income. It is probably the most important figure for your tax return, but it may not accurately represent your total earnings. Certain sources of income are untaxable (such as foreign investment income).
These non taxable sources are added back into your AGI to calculate your MAGI. So your MAGI is a better description of your ability to pay for education, adoption, or any of the other credits the Federal government may provide.
Calculating Your Modified Adjusted Gross Income (MAGI)
The IRS posts a deceptively simple MAGI calculator on its website, which helps taxpayers and tax professionals determine their MAGI. However, closer inspection reveals a host of terms that sound intuitive but are extremely complex. After a closer look on the page, you might wonder: What is passive income? And why am I adding deductions back into my AGI? The major sticking points are explained in this article.
Any Passive Loss or Passive Income
This is determined on Form 1040 Schedule E, and is defined as any income or loss that occurred without active engagement. Limited partnerships are one example, in which an individual might not actively manage a firm but still own a percentage. Ownership would transfer passive income or losses onto your AGI but not MAGI.
Passive losses could include any losses from rental property. If you own a rental property that has operating costs greater than the revenue it generates, you would record a passive loss. (Qualified real estate agents do not consider these passive losses because real estate activity counts as their active income.)
Passive losses cannot be deducted from active income, which can be a thorn in the side of many small business owners. However, if your MAGI is less than $100,000, you are allowed to deduct up to $25,000 in real estate losses each year. To qualify for the deduction, the IRS requires that you participate in the rental activity by contributing to impactful management decisions.
Taxable Social Security Benefits
Most Americans will not be taxed on their Social Security benefits, but some of your social security could be taxable. Approximately one-third of people who receive Social Security are required to pay taxes on their benefits. Your filing status and income level will determine whether your Social Security payments are subject to tax. In general, your benefits are not considered taxable as long as Social Security is your sole source of income.
Your Social Security may be taxed if you earn income from other sources and your MAGI exceeds the base amount for your filing status. To determine this, take 50% of the Social Security benefits you received and add that to all your other income. If your total is greater than the following base amount, your Social Security benefits may be taxable:
• $32,000 for married filing jointly
• $25,000 for single, married filing separately (who lived apart during the entire year), head of household, and qualifying widow(er) with dependent child
• $0 for married filing separately (who lived together during the year)
Your MAGI is determined by taking your AGI and “adding back” certain deductions. These are items which can be subtracted from your AGI, but must be included in the calculation of your MAGI:
• ½ of self-employment tax (self-employed individuals are required to pay “payroll” taxes that an employer would otherwise take; these extra taxes can be deducted from AGI, but are included in MAGI)
• Student loan interest
• Tuition and fees deduction
• Qualified tuition expenses
• Passive income or loss
• Rental losses
• IRA contributions and taxable Social Security payments
• Exclusion for income from U.S. savings bonds
• Exclusion for adoption expenses (under 137)
Most of the above deductions are rare, so don’t be surprised if your AGI and your MAGI are the same.
Your Modified Adjusted Gross Income is simply your Adjusted Gross Income with certain deductions and exclusions added back to it. Think of it as the next step for the AGI, and is used by the IRS to see if you qualify for the tax benefits you applied for in your tax return, like tax credits, as well as some other things such as IRA contributions.
2. What’s the difference between MAGI and AGI?
Simply put, your AGI comes from your gross income but with certain deductions subtracted from it, like student loan interest or contributions to an IRA. On the other hand, MAGI is your AGI with some of those deductions (and a few other things) added to it, like tax-exempt income and other benefits. In a nutshell, AGI is your gross income minus some things, and MAGI is your AGI plus some things (that you originally subtracted from it)..
3. What are the things that turn AGI into MAGI?
The most common additions to the MAGI are tax-exempt interests (such as municipal bond income), any foreign-earned income under the Foreign Earned Income Exclusion, and some deductions originally taken from your gross income to calculate your AGI.
4. What credits are determined by my MAGI?
There are a few credits and tax benefits determined by your MAGI, for example:
Traditional and Roth IRA contributions limits.
Premium health insurance tax credits under the ACA.
Some government assistance programs and credits, like the EITC.
Deductions for student loan interest.
5. How do I calculate my MAGI?
It’s simple in theory. All you have to do is take your AGI from your tax return, then add specific amounts back to it. You can consult the IRS for specifics on what amounts are needed for specific tax benefits or credits.
6. Does that mean there are different MAGIs?
In a sense, yes. There are different adjustments you have to make to your AGI in order to get the MAGI required for specific tax benefits or programs. For example, the MAGI required for Roth IRA contributions is different from the one you would calculate for healthcare premium tax credits.
7. I can’t find my AGI to start calculating my MAGI.
You AGI should be on line 11 of your Form 1040. Be sure to make a note of it so that you can come back to it easily so you can calculate all the different MAGI required for specific tax benefits.
Markos M. Baños Cabán, Esq., is the Director of Resolutions at Community Tax LLC, where he leads a team of practitioners and service professionals dedicated to resolving complex tax conflicts, including IRS audits, tax liens, and tax debt. A licensed attorney, tax practitioner, and notary public in Puerto Rico, Markos combines his extensive legal expertise and management skills to deliver exceptional results and reduce stress for his clients. He holds a Juris Doctor from the University of Puerto Rico School of Law and has experience in a variety of legal fields, as well as industrial management. Bilingual in English and Spanish, Markos is also a published researcher with a passion for delivering outstanding service.
