In calculating personal income tax, it's important to understand the relationship between the terms adjusted gross income (AGI) and modified adjusted gross income (MAGI), as they can affect the amount of taxes that you owe.

By subtracting certain deductions from your gross income, AGI can reduce the amount of your taxable income. MAGI, on the other hand, can take away some of those deductions because, as your income increases, the Internal Revenue Service (IRS) begins to disallow certain deductions and credits.

To oversimplify the situation, you may want to think of AGI as "giving" deductions and MAGI as "taking away" those deductions.

Key Takeaways

  • Adjusted gross income (AGI) and modified adjusted gross income (MAGI) are calculations that help the IRS determine whether taxpayers may take advantage of certain credits and deductions.
  • AGI can reduce the amount of your taxable income by subtracting certain deductions from your gross income.
  • But MAGI can add back those deductions, where the IRS disallows certain deductions and credits.

How Are AGI and MAGI Used?

The IRS allows individual taxpayers to use tax deductions and applicable credits based on AGI and MAGI calculations to reduce their total tax liability. It's normal for a person's MAGI to be similar to or the same as their AGI. However, these calculation tools may result in small differences that can greatly affect an individual's tax return.

Adjusted Gross Income

Gross income is the sum of all that you earn in a year, including wages, dividends, alimony, capital gains, interest income, royalties, rental income, and retirement distributions. Adjusted gross income is a modification of gross income; it factors in allowable deductions from your gross income to reach the figure for which your income taxes will be calculated. Generally, AGI is more useful than gross income for individual tax purposes.

Calculating AGI

To reach AGI, you add all income earned during the year and subtract any allowable adjustments, such as educator expenses, self-employed retirement or individual retirement account (IRA) contributions, interest on student loans, and alimony paid under a divorce agreement entered into on or before December 31, 2018. To arrive at AGI, you also may deduct 50% of self-employment taxes you paid and self-employed health insurance premiums for you and your family members.

AGI's Effects on Your Taxes

Your AGI directly influences your eligibility to claim many of the deductions and credits available on your tax return. Both the earned-income credit and the child and dependent care credit depend on AGI calculations. Similarly, tax deductions, including mortgage insurance premiums and medical expense deduction thresholds, are based on your AGI.

You may want to think of AGI as "giving" IRS tax deductions and MAGI as "taking away" those deductions.

Modified Adjusted Gross Income

Adjusted gross income is an important but intermediate step in determining how much of one's gross income is taxable. MAGI modifies the adjusted gross income by adding back certain items such as foreign earned income, student loan interest, and the excluded portion of adoption expenses. For most taxpayers, MAGI is simply AGI with the student loan interest deduction added back in.

Calculating MAGI

To calculate MAGI, taxpayers add certain adjustments back to the AGI total to determine whether they can take full advantage of tax perks, according to the IRS. Tuition-related costs or deductions, losses from rental properties, 50% of self-employment tax paid, and student loan interest are common adjustments added back to arrive at MAGI. At certain income levels, the IRS begins to phase out deductions for items such as IRA contributions and expenses related to education.

MAGI's Effects on Your Taxes

Most notably, the IRS uses the MAGI figure to determine how much of an individual's IRA contribution is deductible and whether an individual is eligible for premium tax credits. The higher the MAGI, the fewer deductions you can take on IRA contributions. If the MAGI is too high, IRA deductions can even reach zero. If this happens, you can still contribute to an IRA plan, but cannot deduct any of the contributions on your taxes.

Additionally, MAGI will dictate whether an individual is eligible for certain benefits as outlined by the Affordable Care Act, as it stands today.