MAGI vs AGI, what is the difference?
Published on June 05, 2024
by Deborshi Choudhury, EA
Deborshi Choudhury, an IRS Enrolled Agent with 17 years of expat tax experience, specializes in U.S. tax preparation, tax planning, and tax advice for U.S. citizens and Green Card holders living and working in the UAE and Canada.
Table of Contents
The difference between Modified Adjusted Gross Income (MAGI) and Adjusted Gross Income (AGI) is in the adjustments added back to AGI to determine MAGI. However, both of these are important for US taxpayers, especially when qualifying for various tax benefits.
What is Adjusted Gross Income (AGI)?
AGI is your total gross income minus specific deductions, known as adjustments. It determines your taxable income and eligibility for various tax credits and deductions.
To calculate AGI, you start with your total or gross income, which includes wages, dividends, capital gains, business income, and other earnings. From this total, you subtract specific deductions, known as adjustments. These adjustments can lower your taxable income and potentially your tax bill.
Common Adjustments Subtracted from Gross Income to Calculate AGI
- Student Loan Interest: Up to $2,500 of interest paid on qualified student loans can be deducted.
- Retirement Contributions: Contributions to traditional IRAs, 401(k)s, and certain other retirement accounts can be deducted.
- Tuition and Fees: Qualified education expenses, up to a certain limit, can be subtracted.
- Health Savings Account (HSA) Contributions: Contributions to an HSA can reduce your gross income.
- Self-Employment Taxes: A portion of the self-employment tax can be deducted.
- Alimony Payments: For divorces finalized before 2019, alimony payments can be deducted.
- Moving Expenses: For active-duty military personnel, moving expenses can be deducted.
These adjustments are designed to account for significant expenses that reduce your disposable income. By subtracting them from your gross income, the tax system provides a more accurate representation of your financial situation.
Example Calculation of AGI
Let’s say you have a total gross income of $85,000.
- This includes wages, salary, and any other income sources.
Adjustments to Income:
- Student Loan Interest: $1,500
- Traditional IRA Contribution: $3,000
- Health Savings Account (HSA) Contribution: $2,000
AGI = Gross Income – (Student Loan Interest + IRA Contribution + HSA Contribution)
AGI = $85,000 – ($1,500 + $3,000 + $2,000)
AGI = $85,000 – $6,500
AGI = $78,500
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What is Modified Adjusted Gross Income (MAGI)?
MAGI is AGI with certain adjustments added back in. These adjustments can include items like foreign income, tax-exempt interest, and deductions for student loan interest.
To calculate MAGI, you begin with your AGI and then add back specific items. These items typically include income and deductions that were excluded when calculating your AGI but are considered for certain tax purposes.
Items That Are Typically Added Back to AGI to Calculate MAGI
Several adjustments are commonly added back to AGI to arrive at MAGI. Here are a few:
- Foreign Earned Income: If you exclude foreign earned income from your AGI, it is added back to calculate MAGI.
- Tax-Exempt Interest: Interest from tax-exempt bonds is added back.
- Deductions for Student Loan Interest: This deduction is added back to AGI for MAGI calculations.
- IRA Contributions: Deductions for contributions to traditional IRAs are added back.
- Rental Losses: If you have rental losses, these might be added back depending on the context.
These additions ensure that the MAGI calculation reflects a more complete view of your income, particularly for determining eligibility for certain tax benefits.
Example Calculation of MAGI
Let’s start with the AGI calculated above.
AGI = $78,500
Now, we add items (the amount added depends on each individual).
- Foreign Earned Income Exclusion: $5,000
- Tax-Exempt Interest: $1,000
- Student Loan Interest Deduction: $1,500 (added back)
- IRA Contribution Deduction: $3,000 (added back)
MAGI = AGI + (Foreign Earned Income + Tax-Exempt Interest + Student Loan Interest + IRA Contribution)
MAGI = $78,500 + ($5,000 + $1,000 + $1,500 + $3,000)
MAGI = $78,500 + $10,500
MAGI = $89,000
How is AGI used to determine eligibility for various tax credits and deductions?
Many tax benefits have income thresholds, and your AGI determines whether you qualify, so understanding your AGI is crucial. It directly affects your eligibility for some tax benefits. You can potentially increase your tax savings by lowering your AGI through allowable adjustments.
Here are some examples:
- Earned Income Tax Credit (EITC): This credit is available to low- and moderate-income workers, and eligibility is based on your AGI.
- Child Tax Credit: The amount of this credit can be reduced if your AGI exceeds certain limits.
- American Opportunity and Lifetime Learning Credits: These education credits also depend on your AGI.
- Medical and Dental Expense Deductions: You can only deduct these expenses if they exceed a certain percentage of your AGI.
How is MAGI used to determine eligibility for specific tax benefits and programs?
MAGI is often used to determine eligibility for a variety of tax benefits and government programs.
Here are some examples:
- Roth IRA Contributions: Eligibility to contribute to a Roth IRA is based on your MAGI. If your MAGI exceeds certain limits, you may be unable to contribute.
- Premium Tax Credits: These credits, which help lower the cost of health insurance purchased through the Health Insurance Marketplace, are based on your MAGI.
- Education Credits: Certain education credits, such as the American Opportunity Credit and the Lifetime Learning Credit, have MAGI limits.
- Medicare Part B and D Premiums: Higher-income individuals with a higher MAGI may pay higher premiums for Medicare Part B and Part D.
Why does understanding the difference matter?
Knowing the difference between AGI and MAGI is essential because these play different roles in the tax system. AGI is the starting point for calculating your taxable income and determines your eligibility for many deductions and credits. Conversely, MAGI is used to assess your eligibility for specific tax benefits and government programs that AGI alone doesn’t cover.
For instance, AGI influences whether you can claim deductions for student loan interest, IRA contributions, and medical expenses. Meanwhile, MAGI determines your eligibility for Roth IRA contributions, premium tax credits for health insurance, and other benefits.
This is why getting a tax professional’s help is highly recommended. They can help identify all possible deductions and credits you qualify for, maximizing your tax savings.
You might even make mistakes in calculating AGI or MAGI, which can lead to incorrect tax filings, potential penalties, and missed opportunities for tax savings. A professional can help you avoid these errors.
The best part is that they provide personalized advice based on your financial situation, helping you make informed decisions that benefit your long-term financial health.
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