What Is Modified Adjusted Gross Income?

Why adjusted gross income (AGI) is inadequate in your tax calculations for the IRS

Brandon Lafving
by Brandon Lafving, IRS contributor (@TechDragoon)

 

Modified Adjusted Gross Income (MAGI) can qualify you for a number of credits, benefits, and exclusions, which makes it important to calculate for tax purposes.

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.

READ: The Pros and Cons of Professional Tax Preparation

So why does the IRS use MAGI as a basis instead of your Adjusted Gross Income (AGI)?

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 untaxable 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 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.

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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)

READ: How to Determine Your Filing Status

Deductions Not Applicable to MAGI

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. 

READ: Understanding the Different Types of Individual Income Tax Returns