Clark Stott has been with Expat Tax Online since 2015. Being a dual national based in the UK, Clark has unique experience helping US citizens (and Accidental Americans) become tax compliant via the Streamlined Tax Amnesty program. Clark likes to help Americans in the UK keep their tax situations as simple as possible to avoid harsh IRS treatment.
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AGI determines your taxable income and eligibility for various tax credits and deductions, while MAGI is used to determine eligibility for certain tax benefits, such as the premium tax credit for health insurance, traditional IRA deductions, and the ability to contribute to a Roth IRA.
What is Adjusted Gross Income (AGI)?
AGI is your total income minus specific deductions, used to determine your taxable income and eligibility for tax credits and deductions.
Common Adjustments to Calculate AGI:
- Student Loan Interest: Deduct up to $2,500 of interest paid on qualified student loans.
- Retirement Contributions: Deduct contributions to traditional IRAs, 401(k)s, and certain other retirement accounts.
- Tuition and Fees: Deduct qualified education expenses up to a certain limit.
- Health Savings Account (HSA) Contributions: Deduct contributions to an HSA.
- Self-Employment Taxes: Deduct a portion of the self-employment tax.
- Alimony Payments: Deduct alimony payments for divorces finalized before 2019.
- Moving Expenses: Deduct moving expenses for active-duty military personnel.
Example Calculation of AGI:
- Gross Income: $85,000 (includes wages, salary, and other income sources)
- Adjustments to Income:
- Student Loan Interest: $1,500
- Traditional IRA Contribution: $3,000
- Health Savings Account (HSA) Contribution: $2,000
- AGI = Gross Income – (Student Loan Interest + IRA Contribution + HSA Contribution)
- AGI = $85,000 – ($1,500 + $3,000 + $2,000)
- AGI = $85,000 – $6,500
- AGI = $78,500
What is Modified Adjusted Gross Income (MAGI)?
MAGI is AGI with certain adjustments added back in, used to determine eligibility for specific tax benefits.
Items Typically Added Back to AGI to Calculate MAGI:
- Foreign Earned Income: If you exclude foreign earned income from your AGI, it is added back to calculate MAGI.
- Tax-Exempt Interest: Interest from tax-exempt bonds is added back.
- Deductions for Student Loan Interest: This deduction is added back to AGI for MAGI calculations.
- IRA Contributions: Deductions for contributions to traditional IRAs are added back.
- Rental Losses: Rental losses might be added back depending on the context.
Example Calculation of MAGI:
- AGI: $78,500
- Add Items:
- Foreign Earned Income Exclusion: $5,000
- Tax-Exempt Interest: $1,000
- Student Loan Interest Deduction: $1,500 (added back)
- IRA Contribution Deduction: $3,000 (added back)
- MAGI = AGI + (Foreign Earned Income + Tax-Exempt Interest + Student Loan Interest + IRA Contribution)
- MAGI = $78,500 + ($5,000 + $1,000 + $1,500 + $3,000)
- MAGI = $78,500 + $10,500
- MAGI = $89,000
How is AGI used to determine tax credit and deduction eligibility?
Many tax benefits have income thresholds, and your AGI determines whether you qualify. Here are some examples:
- Earned Income Tax Credit (EITC): Available to low- and moderate-income workers, eligibility depends on your AGI.
- Child Tax Credit: The credit amount may reduce if your AGI exceeds certain limits.
- Education Credits: Both the American Opportunity and Lifetime Learning Credits depend on your AGI.
- Medical and Dental Expense Deductions: These expenses are deductible if they exceed a specific percentage of your AGI.
How does MAGI determine eligibility for tax benefits and programs?
MAGI is crucial for determining eligibility for various tax benefits and government programs. Here are some examples:
- Roth IRA Contributions: Your eligibility to contribute depends on your MAGI.
- Premium Tax Credits: These credits help reduce the cost of health insurance and are based on your MAGI.
- Education Credits: Credits like the American Opportunity Credit and the Lifetime Learning Credit have MAGI limits.
- Medicare Premiums: Higher-income individuals with a higher MAGI may pay higher premiums for Medicare Part B and Part D.
Why is understanding the difference between AGI and MAGI important?
Understanding the difference is essential because AGI and MAGI play different roles in the tax system. AGI is the starting point for calculating your taxable income and determines your eligibility for many deductions and credits. In contrast, MAGI assesses eligibility for specific tax benefits and government programs that AGI alone doesn’t cover.
- AGI: Influences deductions for student loan interest, IRA contributions, and medical expenses.
- MAGI: Determines eligibility for Roth IRA contributions, premium tax credits, and other benefits.
