The different income measures can become confusing at tax time. Your gross income, adjusted gross income and modified adjusted gross income all are factors in various aspects of tax filing. Modified adjusted gross income, or modified AGI, plays a role in your eligibility for deductions and credits that can substantially lower your tax burden.
To understand modified AGI, you first have to know what AGI means. Your adjusted gross income, the primary figure that determines your taxable income and corresponding tax rate, is your total income — usually wages and interest, and possibly other sources such as unemployment benefits — minus allowable deductions and exemptions. For the 2010 tax year, you get an exemption of $3,650 for yourself, your spouse if you file together and for each dependent. In addition, the standard deduction is $5,700, and you have the choice to itemize your deductions instead of taking the standard deduction.
Certain itemized deductions do not apply when considering your modified adjusted gross income. Modified AGI is your adjusted gross income plus these deductions added back in: deductible IRA contributions, student loan interest, higher-education tuition and fees, and U.S. Savings Bond interest used for higher-education expenses. You would also add back three more deductions, but these do not apply to most people: some employer-adoption assistance payments, some foreign-earned income and housing-cost reimbursements, and domestic production activities.
Your modified AGI is the benchmark for determining how much of a deduction you can take on IRA contributions when you file taxes. In 2011, for example, you can take a full deduction on IRA contributions if you file a joint return and your modified AGI is less than $167,000. Modified AGI also determines eligibility for deductions for tuition and fees, as well as for student-loan interest. It also factors into whether you can take various credits. One example is the child tax credit, which begins decreasing in value if you file a joint return and your modified AGI exceeds $110,000 as of the 2010 tax year, or if your filing status is single and your modified AGI exceeds $75,000. Modified AGI also factors in to eligibility for education credits such as the American Opportunity credit, which begins decreasing with a modified AGI of $80,000 for singles or $160,000 for joint returns.
Those deductions and credits can save you thousands of dollars, depending on your situation. If, as the tax year draws to a close, you project that you will not qualify for some of them, you might be able to make yourself eligible by lowering your modified AGI. The key to lowering it, as a column on the Kiplinger's Personal Finance website points out, is to decrease your AGI using reductions that will not have to be added back in when tallying your modified AGI. One option that might do the trick is increasing deductible contributions to a 401k or 403b — but not to an IRA, since, as previously mentioned, you would have to add that deduction back in when calculating your modified AGI. You could also sell stocks and other investments for a loss, contribute to a health savings account if you are eligible to do so, itemize deductions such as alimony and moving expenses if those apply to you, and lower any income from self-employment.
- IRS.gov: Publication 501 (2010), Exemptions, Standard Deduction and Filing Information
- Fairmark.com; Modified Adjusted Gross Income; Kaye A. Thomas; January 2008
- SmartMoney.com; My Kids Are Worth How Much?; Stacey L. Bradford; January 2011
- Kiplinger; How to Lower Your Adjusted Gross Income; Kimberly Lankford; November 2008
- Bankrate.com: Determining Taxable Income