A taxpayer’s modified adjusted gross income (MAGI) potentially affects other components of their tax situation. What you may not know is that it’s possible to have multiple adjusted gross income amounts for the year. Learning how to calculate and reduce your MAGI amounts, you save you some money come tax time.
What Is Modified Adjusted Gross Income?
You can calculate your modified adjusted gross income by adding and possibly subtracting certain amounts—such as tax adjustments or tax-exempt income—to and from your adjusted gross income. The specific amounts depend on the context in which a taxpayer uses the modified adjusted gross income figure.
How to Calculate Modified Adjusted Gross Income
The modified adjusted gross income calculation depends on what the taxpayer is using the adjusted gross income amount for.
For example, there is a modified adjusted gross income calculation to determine who must pay the net investment income tax. There is another modified adjusted gross income calculation to determine who can contribute directly to a Roth IRA.
The calculation of modified adjusted gross income can be very different in one tax context than in another. However, all modified adjusted gross income calculations start with the taxpayer’s adjusted gross income. Gross income is the total income that is subject to tax minus adjustments allowed by the tax code. Allowed adjustments are reported on Schedule 1 of Form 1040.
MAGI for Net Investment Income Tax
The modified adjusted gross income calculation for the net investment income tax is straightforward:
- Add to a taxpayer’s adjusted gross income: any foreign-earned income excluded due to the foreign-earned income exclusion.
- Subtract any deductions they would have been eligible to take against their foreign income if not for the foreign-earned income exclusion.
If the modified adjusted gross income that results from the above calculation is greater than a certain amount for their filing status, they are obligated to pay the net investment income tax on net investment income.
MAGI for Roth IRA
The calculation of modified adjusted gross income for Roth IRA purposes is a bit more involved. It requires the following modifications to a taxpayer’s adjusted gross income:
- Subtracting any IRA conversion income amounts.
- Adding the amounts taken as deductions for traditional IRA contributions, student loan interest, and foreign housing.
- Adding the amounts of tax-exempt qualified savings bonds interest, tax-exempt employer-provided adoption benefits, and excluded foreign income not included in the taxpayer’s adjusted gross income.
If the taxpayer’s modified adjusted gross income for Roth IRA purposes exceeds certain threshold amounts, they are ineligible to contribute directly to a Roth IRA without paying a 6% annual excise tax. However, they may avoid these restrictions by utilizing the backdoor Roth IRA strategy. Taxpayers should note the “pro-rata rule.” It states that Roth IRA conversions could trigger taxes if a taxpayer has significant traditional IRA balances they made deductible contributions to in prior years.
The Roth-modified adjusted gross income calculation is more complex for high-income taxpayers. If they meet both of the following qualifications, the taxpayer has the option to reconfigure their original adjusted gross income for Roth IRA purposes when calculating their modified adjusted gross income.
- A taxpayer’s tentative modified adjusted gross income amount based on the calculation above exceeds certain amounts based on their filing status.
- They have income or loss items whose amounts are affected by the amount of the taxpayer’s adjusted gross income.
How Modified Adjusted Gross Income Is Used
A modified adjusted gross income calculation is used in various federal income tax and other contexts, including eligibility and/or the amount allowed or owed for:
- Deductions for contributions to a traditional IRA if a retirement plan at work covers the individual or their spouse
- Roth IRA contributions
- American Opportunity Tax Credit
- Child Tax Credit
- Lifetime Learning Credit
- Net Investment Income Tax
- Premium Tax Credit
- Retirement Savings Contribution Credit
- Special Allowance to the Passive Activity Loss Rules for Rental Real Estate Activities
- Student Loan Interest Deduction
Why Your Modified Adjusted Gross Income Matters
Your modified adjusted gross income matters because it directly affects your ability to take advantage of certain tax benefits.
For example, say you project your modified adjusted gross income for Roth IRA purposes next year to be slightly higher than the income limit for your filing status. But you do not want to do a backdoor Roth IRA due to the pro-rata rule.
In this case, some smart tax planning could allow you to contribute to a Roth IRA without using the backdoor method.
For example, if you are in the process of adopting a child, you could ask your employer to accelerate the payment of employer-provided adoption benefits to this year.
Or suppose you own tax-exempt qualified savings bonds. In that case, you may consider shifting those investments to tax-exempt municipal bonds whose interest will not increase your modified adjusted gross income for Roth IRA purposes.
So while doing modified adjusted gross income calculations may not be the most exciting way to spend your time, doing so may uncover some tax nuggets that will put more money back in your pocket.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.