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4 Min. Read

Why Your Modified Adjusted Gross Income (MAGI) Matters

Published
People calculating their modified adjusted gross income (Magi)

A taxpayer’s modified adjusted gross income (MAGI) potentially affects other components of their tax situation. What you may not know, though, is that it’s possible for a filer to have multiple adjusted gross income amounts for the year. By learning how to calculate—and reduce—your modified adjusted gross income amounts, you may be able to save some money come tax time. 

What Is Modified Adjusted Gross Income? 

Modified adjusted gross income is determined by adding and possibly subtracting certain amounts—such as tax adjustments or tax-exempt income—to and from a taxpayer’s adjusted gross income. The specific amounts to be added depends 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 adjusted gross income amount is used for. 

For example, there is a modified adjusted gross income calculation to determine who is obligated to pay the net investment income tax and a modified adjusted gross income calculation to determine who is eligible to contribute directly to a Roth IRA

While the calculation of modified adjusted gross income can be very different in one tax context than in another, all modified adjusted gross income calculations start with the taxpayer’s adjusted gross income. Gross income is the total income subject to tax less certain adjustments allowed by the tax code and reported on Schedule 1 of Form 1040—and add and subtract certain amounts to and from it. 

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 they excluded from their income 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 taxpayer’s modified adjusted gross income as a result of the calculation above is greater than a certain amount for their filing status, they are obligated to pay the net investment income tax if they have net investment income. 

MAGI for Roth IRA 

The calculation of modified adjusted gross income for Roth IRA purposes is a bit more involved, requiring 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 that due to the “pro-rata rule,” Roth IRA conversions could trigger taxes if a taxpayer has significant traditional IRA balances to which they made deductible contributions in prior years. 

The Roth-modified adjusted gross income calculation is more complex for high-income taxpayers. The taxpayer has the option to reconfigure their original adjusted gross income for Roth IRA purposes when calculating their modified adjusted gross income if both of the following are met: 

  • 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, let’s say that 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, and 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. 

Just by way of example, if you are in the process of adopting a child, perhaps you could ask your employer if they could 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.