Each year, many people put money into their 401k plans and have their employers make matching contributions to help save for retirement. Knowing how these contributions affect your modified adjusted gross income helps you better determine whether you qualify for a range of income tax deductions and credits.
401k Contributions on Taxes
Unlike traditional IRA contributions, money you defer into your 401k plan does not get included on your income taxes, nor does it get deducted. When your employer sends you a W-2 form at the end of the year, your wages in box 1, the amount you report on your income taxes, does not include your deferred compensation into your 401k plan. For example, if your salary equals $75,000 but you deferred $10,000 into your 401k plan, your W-2 form would only show a salary of $65,000 and you would only report $65,000 of taxable income.
Employer Contributions to Your 401k Plan
Your employer has the ability to make a 401k plan contributions on your behalf each year. These contributions do not affect your income taxes because they do not count as taxable income in the year the employer makes the contributions. Instead, you only pay taxes on employer contributions when you remove the money from your 401k plan. Therefore, your employer contributions to your 401k plan also do not affect your modified adjusted gross income.
Significance of Modified Adjusted Gross Income
Knowing your modified adjusted gross income is important for multiple tax deductions and credits. Deductions determining eligibility based on modified adjusted gross income include the traditional IRA deduction when you or your spouse are covered by an employer plan, the tuition and fees deduction and the student loan interest deduction. Credits include the American Opportunity Credit and the Lifetime Learning Credit. Miscalculating your modified adjusted gross income can cause you to claim a tax break you are ineligible to claim or to ignore a tax break.
Calculating Modified Adjusted Gross Income
The formula for modified adjusted gross income adds back several income tax deductions to your adjusted gross income. If you use Form 1040, your adjusted gross income is located on line 38. If you use Form 1040A, the adjusted gross income is found on line 22. The specific deductions you have to add back depends on which deduction for which you need to calculate your modified adjusted gross income. For example, when calculating your modified adjusted gross income for traditional IRA contributions you must add back your IRA deduction, but you do not have to add back your IRA deduction when calculating your MAGI for the purposes of the student loan interest deduction.