Once a year, when tax time comes around, you get the terms gross income, adjusted gross income (AGI), and modified adjusted gross income (MAGI) shoved in your face… a lot. And since you’re only faced with having to know what these somewhat ambiguous tax terms mean once a year, they are very easy to forget. Heck, I already did.
So, what I’m going to do in this post is highlight what each of these terms mean, where you will encounter them, and why they are important to know so that you can refer back to this post in the future when the ambiguity returns.
Gross Income (aka Gross Earnings)
We’ll start with the easy one. Gross income is simply the total money, or income, that you receive per year before any deductions and taxes are taken out. Gross income is also referred to as ‘gross earnings’, ‘total income’, or simply ‘gross’. At first, you might just think, OK, it’s my salary, simple enough. Not quite. The IRS is the net sum of all of the following income sources on your 1040:
- taxable interest
- ordinary dividends
- taxable refunds, credits, or offsets of state and local income taxes
- alimony received
- business income or loss
- capital gains or losses
- other gains or losses
- taxable IRA distributions
- taxable pensions and annuities
- rental real estate
- farm income or losses
- unemployment compensation
- taxable Social Security benefits
- and other income
All of these income sources add up to the ‘total income’ amount on line 7b of your 1040.
In some cases, you may be below the threshold of minimum income to file taxes, and not be legally required to submit a return. However, you may still benefit from doing so, if you are eligible for at least one of the many refundable tax credits available.
Adjusted Gross Income (AGI)
Thankfully, we aren’t taxed on gross income. We get to subtract a number of deductions. Your gross income minus all of these deductions is what becomes your adjusted gross income (AGI) or Net Income. What deductions do you get to subtract from your gross income on your 1040?
- IRA and self-employed retirement plan contributions (i.e. SEP IRA, SIMPLE IRA, and qualified plans)
- Alimony payments (for divorce agreements prior to 2019)
- Self-employed health insurance payments
- One-half of any self-employment taxes paid
- Health Savings Account (HSA) contributions
- Penalties on the early withdrawal of savings
- Educator expenses
- Student loan interest
- Moving expenses (for tax years prior to 2018)
- Tuition and fees
- Deductions for domestic production activities (for tax years prior to 2018)
- Certain business expenses of performing artists, reservists, and fee-basis government officials
Adjusted gross income is reported on line 8b of your 1040.
Neither the standard deduction or itemized deductions are factored into your adjusted gross income.
Modified Adjusted Gross Income (MAGI)
Modified adjusted gross income (MAGI) are important because they are used to calculate income phaseout limits that indicate what your Roth IRA, SEP IRA, SIMPLE IRA and traditional IRA maximum contribution limits are. And doing things to reduce your income such as increasing to the maximum 401k contribution, might actually lower your overall MAGI and allow you to contribute more to your IRA’s.
The IRS defines MAGI as:
AGI with the addition (subtraction) of the following deductions:
- Any passive loss or passive income
- Any rental losses (whether or not allowed by IRC § 469(c)(7))
- IRA contribution, taxable Social Security
- One-half of self-employment tax
- Exclusion under 137 for adoption expenses
- Student loan interest
- Exclusion for income from US savings bonds (to pay higher education tuition and fees)
- Qualified tuition expenses
- Foreign earned income exclusion
- Foreign housing exclusion or deduction
- Tuition and fees deduction
- Any overall loss from a PTP (publicly traded partnership)
Also, in order to qualify for the retirement savings contribution credit, you must have an adjusted gross income under these limits, for 2019:
- $32,000 for single filers and married individuals filing separately
- $48,000 for heads of household
- $64,000 for married couples filing jointly
And for 2020:
- $32,500 for single filers and married individuals filing separately
- $48,750 for heads of household
- $65,000 for married couples filing jointly
There you have it – gross income, adjusted gross income, and modified gross income in a nutshell. I’ll be referencing these terms in some upcoming posts. No quizzes at the moment.