The Internal Revenue Service requires that you calculate and include both your adjusted gross income and modified adjusted gross income on annual income tax returns. Your AGI represents taxable income after subtracting allowable deductions. The IRS uses your taxable income to determine your annual tax debt. Although important, AGI reflects neither your true annual income nor your ability to qualify for tax credits and programs the federal government provides. For these, you need to add some income and tax deductions back in, hence the name modified AGI.
What MAGI Includes
IRS Publication 590 includes a worksheet for calculating MAGI. Essentially, it adds certain untaxable income and a number of tax deductions back into your AGI. These include current year tax deductions for IRA contributions, student loan interest and tuition and fees and interest from EE savings bonds used to pay higher education expenses. MAGI also includes employer-paid adoption expenses, Social Security benefits, untaxed foreign income, dividends and net self-employment profits.
How the IRS Uses MAGI
The IRS uses MAGI as one of the eligibility criteria for a number of optional tax deductions and tax credits. These include the Health Insurance Marketplace tax credit, the Hope Scholarship tax credit, the Lifetime Learning tax credit, student loan interest deductions and tuition and fees deductions. In addition, MAGI determines both eligibility and contribution limits for traditional and Roth individual retirement accounts.