Adjusted gross income (AGI) and modified adjusted gross income (MAGI) are two ways to calculate what your income might be for tax purposes. Both these figures directly influence your tax obligations, qualifying for certain tax benefits and deductions. Therefore, knowing when each applies can support your tax-saving strategies and inform financial decisions. Consulting with a financial advisor can also be beneficial to better understand these complex concepts.
Understanding Adjusted Gross Income (AGI)
AGI, or Adjusted Gross Income, is your total income, including wages, interest, dividends and capital gains, minus specific deductions or adjustments. Your AGI is used to calculate the portion of income that Uncle Sam can tax.
Certain types of income, however, are excluded from your AGI. These may include tax-exempt interest, certain Social Security benefits, and qualified distributions from Roth IRAs.
As an example, let’s say Bob has a total income of $50,000. From this, he has $4,000 in student loan interest and $1,000 in healthcare expenses that are deductible. After these deductions, Bob’s AGI will be $45,000.
How Does AGI Influence Your Taxes
Your adjusted gross income (AGI) plays a significant role in determining your federal income tax liability and eligibility for various tax benefits. Here are eight ways in which AGI affects your taxes:
- Tax brackets: Your AGI helps determine which federal income tax bracket you fall into. Different tax brackets have different tax rates, and your AGI is used to calculate the amount of income subject to each rate. A higher AGI may result in a higher tax rate, leading to a higher income tax liability.
- Tax credits: Many tax credits, such as the Child Tax Credit, Earned Income Tax Credit, and the Saver’s Credit, have income phaseouts based on your AGI. If your AGI exceeds certain thresholds, you may become ineligible for or receive reduced tax credits.
- Deductions: Certain itemized deductions, like medical expenses and miscellaneous itemized deductions, have AGI limits. Your ability to claim these deductions may be reduced or limited as your AGI increases.
- Above-the-line deductions: AGI determines your eligibility for above-the-line deductions, also known as adjustments to income. These deductions can reduce your taxable income, and they are often available even if you don’t itemize deductions. Examples of above-the-line deductions include contributions to traditional IRAs, student loan interest and alimony paid.
- Retirement account contributions: The ability to contribute to retirement accounts, such as traditional IRAs, Roth IRAs, and employer-sponsored retirement plans like 401(k)s, is influenced by your AGI. High AGI can limit or phase out your contributions, while lower AGI may allow you to maximize your contributions.
- Alternative minimum tax (AMT): The AMT is calculated based on a modified version of your AGI. If your AGI is relatively high, you may be more likely to trigger the AMT, resulting in a higher overall tax liability.
- Net investment income tax (NIIT): The NIIT applies to certain types of investment income and is triggered when your AGI exceeds specific thresholds. It can result in an additional 3.8% tax on net investment income.
- Social Security benefits taxes: The taxation of Social Security benefits is determined, in part, by your AGI. If your AGI exceeds certain thresholds, a portion of your Social Security benefits may become taxable.
How Modified Adjusted Gross Income (MAGI) Works
MAGI, or Modified Adjusted Gross Income, is basically your AGI, with a twist. It includes most of the items that you originally subtracted from your total income to get your AGI but it puts the other deductions back on the table. MAGI includes sources of income not initially covered in your AGI, such as foreign income, tax-exempt interest and the excluded portion of Social Security benefits.
Your MAGI is used to determine your eligibility for certain tax benefits and assistance programs. Here are eight examples:
- Tax Deductions and credits: MAGI is used to determine eligibility for tax deductions and credits like the student loan interest deduction and the tuition and fees deduction. Additionally, it’s used to calculate income phaseouts for the premium tax credit for health insurance purchased through the health insurance marketplace.
- Roth IRA contributions: MAGI is used to determine eligibility for making contributions to a Roth IRA. If your MAGI exceeds certain limits, you may not be eligible to contribute to a Roth IRA.
- Medicare premiums: For Medicare Part B (medical insurance) and Medicare Part D (prescription drug coverage), your MAGI is used to determine the premiums you pay. Higher MAGI can result in higher Medicare premiums.
- Health savings accounts (HSAs): MAGI is used to determine your eligibility to contribute to an HSA. If your MAGI is too high, you may not be eligible to make contributions to an HSA.
- Eligibility for subsidized health insurance: When applying for health insurance through the health insurance marketplace, your MAGI is used to determine your eligibility for premium tax credits and subsidies. Higher MAGI may reduce or eliminate your eligibility for subsidies.
- Financial assistance programs: In some cases, MAGI is used to determine eligibility for various government assistance programs, such as Medicaid and the children’s health insurance program (CHIP).
- Retirement account deductions: MAGI can affect your ability to deduct contributions to certain retirement accounts, such as traditional IRAs. High MAGI may limit or eliminate your ability to claim these deductions.
- Eligibility for education tax benefits: Your MAGI is used to assess your eligibility for education-related tax benefits, such as the American Opportunity Tax Credit and the Lifetime Learning Credit.
AGI vs. MAGI: Key Differences
Modified adjusted gross income (MAGI) and adjusted gross income (AGI) are both important figures in the U.S. tax system, but they have distinct purposes and calculations. Here are seven key differences:
- AGI is calculated for federal income tax purposes. It serves as the starting point for determining your taxable income and is used to calculate your federal income tax liability.
- MAGI is calculated for various purposes beyond federal income tax. It is used to determine eligibility for specific tax benefits, subsidies, and government assistance programs.
- AGI is calculated by subtracting “above-the-line” deductions (such as contributions to Traditional IRAs and student loan interest) from your total income, including wages, business income, interest, and more.
- MAGI is calculated by adding back certain deductions to your AGI, such as the foreign earned income exclusion, tax-exempt interest, and certain deductions related to rental losses.
Use in taxation:
- AGI is used to determine your federal income tax liability. It affects your tax brackets, eligibility for itemized deductions, and various other tax-related calculations.
- MAGI is used to assess eligibility for specific tax credits, deductions, and subsidies, such as the Premium Tax Credit for health insurance, Roth IRA contributions, and education tax credits.
Impact on tax credits and deductions:
- AGI directly influences the phase-out of certain deductions, like medical expense deductions, and can affect the amount of itemized deductions you can claim.
- MAGI is used to assess eligibility for a wide range of tax credits and deductions, including the Child Tax Credit, the Earned Income Tax Credit, and premium tax credits for health insurance.
- AGI is not directly used to determine Medicare premiums.
- MAGI is used to calculate Medicare Part B and Part D premiums. Higher MAGI can result in higher Medicare premiums.
Subsidies and assistance programs:
- AGI is not typically used to determine eligibility for government assistance programs and subsidies.
- MAGI is used to assess eligibility for subsidies related to health insurance, Medicaid, the Children’s Health Insurance Program (CHIP), and other assistance programs.
- AGI does not directly impact contributions to retirement accounts like Traditional IRAs.
- MAGI is used to determine eligibility for contributions to Roth IRAs. High MAGI may limit or eliminate your ability to contribute to a Roth IRA.
Knowing the key differences between AGI and MAGI are important for your tax planning. These figures not only determine your taxes, but they can also impact your access certain tax benefits and help you potentially optimize your tax savings.
Tips for Tax Planning
- A financial advisor can help you with most financial matters, including tax planning. Their expertise can come in handy with all of your financial activities from making a retirement plan to managing your investments. There are tax considerations in all of it. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to estimate the potential taxes you might pay, consider using SmartAsset’s free tax calculator.
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