Figuring Your IRS Taxable Income – Adjustable Gross Income (AGI) vs. Modified Adjustable Gross Income (MAGI)

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You would think that figuring your income that is subject to taxes would be easy. Unfortunately with our overly complex federal tax system the IRS has multiple definitions of income and it’s important to understand the difference between these because not only can it affect how much you pay in taxes, but also determines what credits, deductions and exemptions you may be allowed to take.

Gross Income

Gross income refers to all earned and unearned income during a given tax year. This includes self-employment income, dividends, interest, alimony, rental income, eligible business income, royalties, and unemployment compensation or Social Security benefits. Losses (e.g. from self-employment) would be a negative number and reduce your gross income. Gifts, inheritances, tax-free social security benefits and tax-exempt interest earnings from state or local bonds are not included in your gross income.

For employees, your gross income is shown on the employer issued W-2 form under box 1 (wages, tips and other compensation). Contractors or those getting a form 1099-MISC can see their gross income reported in reported in Box 7, under non-employee compensation.

Adjusted Gross Income (AGI)
(Total Gross Income – Total Amount of Allowable Deductions)

form 1040 Adjusted Gross IncomeAs the name suggests, adjusted gross income (AGI) is your gross income less IRS allowable adjustments. The IRS allows you to make a number deductions from your gross income if you qualify for them. The deductions are shown in the 1040 IRS tax form and include: qualified IRA plan deductions, medical savings account deductions, moving expenses, 50% of self-employment taxes, 100% of self-employed health insurance deductions, educator expenses, and penalties on early withdrawal of retirement savings, and paid alimony.

You can use your prior year’s tax return (assuming no major work or income changes since filing) to get a quick estimate of your AGI. Depending on the type of tax return you file, you can get your AGI on Line 37 if you filed a form 1040, Line 4 if you filed a Form 1040EZ or Line 21 if you filed a Form 1040A,

Legally lowering your adjusted gross income is a key aspect of smart tax planning because the lower your AGI the more tax benefits you are likely to qualify for, which ultimately results in a smaller tax bill

Your personal exemption, standard or itemized deduction is NOT figured into your AGI. It will be included in your taxable income discussed in the last section.

Modified Adjusted Gross Income (MAGI)
(Adjustable Gross Income + Specified Deductions)

Another classification of income which some would argue is the most important is your modified adjusted gross income, or MAGI. MAGI is calculated based on adjustments to your AGI that the IRS wants you to add back when determining your qualifications for tax credits like EITC, AOTC and the Child Tax Credit and whether you can make tax deductible IRA contributions. Deductions you need to add back to AGI for calculating MAGI include passive income, rental losses, IRA deductions, student loan interest expense, foreign earned income or housing exclusion, employer-paid adoption benefits and taxable savings bond interest income.

Taxable Income

After you figure out your AGI, deduct your personal exemptions and standard or itemized deduction amount to find out how much of your income you’re actually going to have to pay taxes on. Depending on your MAGI and other factors you can then take additional credits to reduce your taxable income.

There are a number of online calculators and forms to help you calculate the above. Additionally, all good tax software can give you an income breakdown in the above categories.

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