You’re likely to encounter modified adjusted gross income during your research for the best way to get through tax season. MAGI is a modified version of adjusted gross income (AGI) used to determine eligibility for certain tax benefits.
If you’re looking to make the most of this tax year, keep reading for a comprehensive understanding of MAGI.
What is modified adjusted gross income?
The Internal Revenue Service (IRS) uses a modified adjusted gross income calculation to determine an individual’s taxable income.
It is a tool used for calculating eligibility for various tax benefits, including:
What is the difference between MAGI and AGI?
AGI is the first step to take when it comes time to determine federal income tax liability. It’s calculated by starting with your taxable income and subtracting certain “above-the-line” deductions, like IRA contributions, student loan interest and alimony payments. The result is your AGI.
On the other hand, MAGI is a modified version of AGI used to determine your eligibility for certain tax benefits and to calculate the taxable Social Security benefits. AGI is a more comprehensive measure of your taxable income rather than the focused calculation of MAGI.
How is MAGI used?
MAGI is used in several ways to determine eligibility for certain tax benefits and other financial assistance programs.
Some of its most common uses include:
- Determining eligibility for tax credits: MAGI is used to determine eligibility for certain tax credits, like earned income tax credit (EITC), the child tax credit and the American opportunity tax credit. The higher your MAGI is, the less likely you will be eligible for these tax credits.
- Calculating the amount of taxable Social Security benefits: MAGI will determine the amount of Social Security benefits subject to federal income tax. Depending on your MAGI, you may owe tax on a portion of your Social Security benefits.
- Determining eligibility for Medicaid and CHIP: MAGI is used to determine eligibility for Medicaid and the Children’s Health Insurance Program (CHIP). Medicaid and CHIP provide health coverage to individuals and families with low incomes. The higher your MAGI, the less likely you are to be eligible.
- Determining eligibility for certain education benefits and educator expenses: Education benefits such as the Lifetime Learning Credit and the Student Loan Interest Deduction will be determined by MAGI. The higher your MAGI, the less likely you will be eligible for these benefits.
- Determining eligibility for retirement plan contributions: Retirement plan contributions, such as contributions to a traditional IRA or a Roth IRA, will be affected by your MAGI. The higher your MAGI, the less likely you are to be eligible to make contributions to these types of retirement plans.
How is MAGI calculated?
- Start with your taxable income: This is the total amount of money you earned from all sources, such as wages, salaries, investment income and business income.
- Subtract adjustments to income: Subtract any “above-the-line” deductions from your taxable income, like traditional IRA contributions, student loan interest or alimony payments.
- Add back certain deductions: Some IRA deductions, such as foreign earned income, are subtracted from taxable income to arrive at adjusted gross income (AGI) but must be added back to arrive at MAGI.
- Subtract qualified deductions: Then subtract any “below the line” deductions from the AGI, including standard deduction or itemized deductions for mortgage interest, state and local taxes and charitable contributions.
- Calculate MAGI: Add any deductions or exclusions subtracted in step three and remove any qualified deductions from step four to get your MAGI.
What are some common tax benefits calculated with MAGI?
While taxes vary for each filer, there are some common tax benefits you might qualify for. Take a look at how MAGI might relate to those benefits.
Roth IRA contributions
A Roth IRA is a type of individual retirement account (IRA) allowable for tax-free withdrawals in retirement. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, which means you don’t receive an immediate tax break for your contributions.
However, the benefit of a Roth IRA is that qualified withdrawals are tax-free in retirement, including any investment gains.
To be eligible to make a full contribution to a Roth IRA, your MAGI must be below certain thresholds. For the 2022 tax year, the MAGI contribution limit is $125,000 for single filers and $198,000 for married couples filing jointly. If your MAGI is $120,000 and you are a single filer, you can make a full contribution to a Roth IRA for the 2022 tax year.
Health savings account (HSA) contributions
A health savings account is a tax-advantaged savings account used to pay for qualified medical expenses. It is typically paired with a high-deductible health plan (HDHP) and is designed to help individuals save for future medical expenses.
HSA contributions are tax-deductible, which can reduce your taxable income and, in turn, your MAGI. To be eligible to contribute to an HSA, you must be covered by a high-deductible health insurance plan and cannot be enrolled in Medicare or other stipulations.
Again, your tax-free HSA contribution eligibility is based on your MAGI. For the 2022 tax year, the MAGI threshold for single filers is $138,000, and for married couples filing jointly, it’s $276,000. If your MAGI is $150,000 and you are a married couple filing jointly, you are not eligible to make tax-free contributions to an HSA for the 2022 tax year.
Earned income tax credit (EITC)
The earned income tax credit (EITC) is a federal tax credit for working individuals and families in the low to moderate-income tax bracket. The credit is based on a percentage of earned income and is designed to increase as earned income increases to help supplement income.
The EITC is available to taxpayers who have earned income from wages, salaries, tips and self-employment and those who receive unemployment compensation.
Premium tax credits under the Affordable Care Act
Premium tax credits under the Affordable Care Act (ACA) are also known as the health insurance premium tax credits, a federal financial assistance program meant to help eligible individuals and families pay for healthcare.
The tax credits are available to those who buy insurance through the Health Insurance Marketplace and meet specific income and coverage requirements.
The tax credit amount is based on your MAGI and the insurance cost. If your MAGI is $35,000 and you are a single filer, you may be eligible for a premium tax credit to help pay for health insurance purchased through the Marketplace.
Related: What is Self-Employment Tax?
Child tax credit
The child tax credit is a tax credit that provides a credit of up to $2,000 per eligible child under the age of 17. The amount of credit you receive depends on your MAGI and the number of children you have. The higher your MAGI, the less likely you are to be eligible for the full amount of the child tax credit.
This means that a single taxpayer with a MAGI of $30,000 and two eligible children would be eligible for a child tax credit of $2,000 per child, for a total credit of $4,000.
What should you keep in mind about MAGI?
- MAGI is not adjusted for inflation: If your MAGI increases due to inflation, you may become ineligible for certain tax benefits or financial assistance programs even though your real purchasing power has not changed.
- MAGI is used for multiple tax forms: MAGI is used for numerous tax forms, including Form 1040, Form 1040A and Form 1040EZ. It is essential to understand which form you need to use and how to calculate your MAGI accordingly.
- MAGI affects more than just your federal income taxes: While MAGI is primarily used for federal tax purposes, it can also impact your eligibility for particular state and local tax benefits and financial assistance programs administered by the state.
- Certain life events can impact MAGI: Life events such as marriage, divorce, childbirth or retirement can affect your MAGI and your eligibility for certain tax benefits or financial assistance programs.
- MAGI is subject to change yearly: Your MAGI can change annually due to changes in your income, deductions or other factors. It’s essential to monitor your MAGI each year and understand how it may impact your financial situation.
Can you change your MAGI?
While it’s not possible to change your MAGI for the previous tax year, it is possible for it to change in the future.
You can do this by:
- Increasing your income: Increasing your income through a job or business is one way to increase your MAGI.
- Reducing your deductions: Reducing your deductions, such as mortgage interest or charitable donations, can increase your MAGI.
- Making contributions to a traditional IRA: Contributions to a traditional IRA can reduce your taxable income and, in turn, your MAGI. However, remember that traditional IRA contributions may be subject to restrictions based on your MAGI and other factors.
- Making contributions to a health savings account: Contributions to a health savings account are tax-deductible, which can reduce your taxable income and MAGI. Remember that you must be enrolled in a high-deductible health plan to be eligible to make HSA contributions.
- Deferring income: Deferring income, such as through a deferral agreement with your employer, can reduce your current year’s income and, in turn, your MAGI.
What does MAGI mean for you?
Your MAGI calculation is critical in determining eligibility for many tax benefits and credits. Maximizing your income tax return benefits is always a good idea.
While you’ve got a comprehensive rundown on MAGI, contacting a tax professional to help you with your IRS forms this time of year never hurts.