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The Purpose of Modified Adjusted Gross Income

As its name implies, modified adjusted gross income, or MAGI, is a variation of your adjusted gross income that’s used by the IRS as an income threshold to qualify for various deductions and credits. But unlike the AGI reported on your tax return, your MAGI isn’t a fixed amount. It can require a different calculation depending on which tax credit or deduction you’re evaluating your eligibility for.

What Is Your AGI

Before you can really see how MAGI works, you’ll need to first understand what your AGI is and how you calculate it. The formula for calculating AGI is the same for every taxpayer; however, if you file your taxes on a 1040A or 1040EZ, the calculation is simplified since these two forms are abbreviated versions of the 1040. Adjusted gross income starts with your “total income,” which includes amounts reported on a W-2 or 1099, self-employment earnings, investment income and any other money you earn that isn’t tax-exempt under the tax law.

From total income you subtract the sum of all deductions you take in the adjusted gross income section of your return, which are referred to as “adjustments to income.” These are specific types of deductions that are unrelated to your itemized or standard deduction that you take in a later section of your return. Some of the adjustments that the IRS typically offers cover one-half of the self-employment taxes you pay, the alimony payments that you’re legally obligated to make and the interest you pay on student loans.

MAGI and Education Credits

The IRS allows students and their parents opportunities to take one of two educational tax credits: the lifetime learning and American opportunity credits. Both credits reduce your income tax bill for the tuition and other school-related expenses you incur during the year. However, your eligibility for both credits depends on whether your income exceeds the MAGI threshold. The IRS calculates your MAGI as AGI plus the income you earn abroad that’s tax-free because of the foreign earned income exclusion and foreign housing exclusion. For example, suppose your AGI is $50,000 after reducing total income by $92,900 under the foreign earned income exclude. You would calculate MAGI by increasing AGI for the exclusion amount. In this case, your MAGI would be $142,900, making you ineligible for either education credit.

MAGI Affects IRA Deduction

When you contribute money to a traditional IRA, some of those amounts may be deductible on your tax return. However, it depends on the filing status you choose and what your MAGI is. For purposes of deducting an IRA contribution, MAGI is equal to your AGI increased by the sum of all “adjustments to income” other than the IRA deduction. And just like the student tax credits, you also need to increase your AGI by the amount of foreign earned income and housing exclusion you take.

Reference: IRS Publication 970-Tax Benefits for Education