Modified Adjusted Gross Income (MAGI)

The IRS uses modified adjusted gross income (MAGI) to determine whether a private individual qualifies for certain tax deductions. Most notably, the IRS uses it to determine how much of an individual's IRA contribution is deductible and whether an individual is eligible for premium tax credits. A taxpayer determines MAGI by taking his adjusted gross income and adding back certain items such as foreign income, foreign-housing deductions, student-loan deductions, IRA-contribution deductions, and deductions for higher-education costs.

The higher the MAGI, the fewer deductions the taxpayer can take on IRA contributions. If the MAGI is too high, IRA deductions can even reach zero. If this happens, one can still contribute to an IRA plan, but the taxpayer cannot deduct any of the contributions on the following year's taxes.

It's normal for an individual's MAGI to be similar or the same to his AGI. However, there may be small differences that greatly affect an individual's tax return. Specifically, these differences will dictate whether an individual is eligible for certain benefits as outlined by the Affordable Care Act, as it stands today. 

A taxpayer must first calculate gross income when calculating MAGI. Gross income (GI) is an individual's total income earned through wages, interest, dividends, rental and royalty income, capital gains, business income and any other means. After calculating GI, an individual then adjusts that income by subtracting qualified deductions from the GI, deriving adjusted gross income (AGI). Allowable deductions are listed on the front page of tax form 1040.

These deductions are made up of standard adjustments, such as retirement plan contributions, student loan interest, tuition, self-employed health insurance payments and others. An individual's AGI is important because it's calculated before itemized or standard deductions, exemptions and credits are taken into account. It dictates how an individual can apply various tax credits and exemptions. For example, AGI affects the amount of money that a taxpayer can claim for the dependent care credit and the child tax credit.

A taxpayer can then calculate MAGI after finalizing AGI. To calculate MAGI, the taxpayer adds back certain deductions to AGI, many of which are rare and not realized by individuals. Therefore, it's fairly uncommon for one's MAGI to differ greatly from AGI. The IRS explains that deductions added back to calculate MAGI include items like student loan interest, tuition, rental loss, and IRA contributions. The MAGI then dictates the use of premium tax credits and retirement plans. For example, eligibility for premium tax credits occurs when an individual's MAGI is less than 400% of the federal poverty line for their family size.