By Dr. Jim Dahle, WCI FounderWe had a suggestion on the WCI forum recently:
“I got tripped up last year thinking that traditional IRA contributions made pre-tax are fully deductible. I want to understand all the definitions the IRS uses to determine my marginal tax rates as well as which tax deductions and tax credits are available to me. Are there WCI or other articles discussing the differences and nuances behind Adjusted Gross Income (AGI), Modified Adjusted Gross Income (MAGI), and taxable income? Are there any other types of income I need to be aware of for personal income tax returns?”
I thought it might be worth discussing with a broader audience. These types of income are generally just lines on the 1040.
What Is Total Income?
On the 2023 Form 1040, total income is found on line 9:
As you can see on Form 1040, your total income includes your wages, taxable (not muni bond) interest, dividends, IRA distributions, pensions, annuities, Social Security, capital gains (and losses), and the long list of “additional income” you can see on Schedule 1.
Lots of interesting stuff there, including Olympic medals, Alaska PFDs, gambling, and alimony. But it mostly just adds in your business income (Schedule C) and partnership income (Schedule E). Basically, all of the income you have that gets taxed is your total income and ends up on line 9.
Uses of Total Income
Besides an intermediate step in the calculation of your tax bill, there are very few things for which your total income is used. It could be used by a landlord or lender looking for your gross income. You'd use it on your personal income sheet or budget, but that's about it.
More information here:
20 Ways to Lower Your Taxable Income for High Earners
3 Big Tax Deductions for Doctors
What Is Adjusted Gross Income (AGI)?
Adjusted Gross Income (AGI) is found on line 11 of Form 1040 (in the top image above). The only line between total income (line 9) and AGI (line 11) is line 10, a carryover from Schedule 1 Part II: Adjustments to Income. These are generally known as “above-the-line” deductions. The “line” is line 11, AGI. Since these tax deductions are taken out of your taxable income to get AGI, they're above AGI or above the line.
Here's what Schedule 1 Part II looks like:
Again, lots of interesting stuff on there—like jury duty pay and court costs for an award from the IRS for ratting out your fellow taxpayers. But for most white coat investors, these deductions are mostly for the self-employed. They include the self-employment tax deduction, contributions to your solo 401(k), health insurance premiums, and HSA contributions. You might also pay some alimony. If your spouse is a teacher, maybe you get some educator expenses. If you're a resident, maybe some of your student loan interest is still deductible.
The bottom line is that your AGI is just your total income minus your above-the-line deductions.
Uses of AGI
AGI is more frequently used than total income. It's obviously an intermediate step en route to calculating your tax bill. However, it is also used to determine your eligibility for various additional credits, deductions, and other government benefits—such as determining Income Driven Repayment (IDR) payments or figuring out how much of your charitable contribution is deductible. There is either a “cliff” or a “phaseout” range where you no longer qualify for many benefits, and that is often stated in terms of AGI.
This is fair because it puts the self-employed on par with employees when these calculations are being made. Why should the self-employed be penalized because their 401(k) deduction is taken out of their income later on the tax form than it is for the employed? They shouldn't. By using AGI instead of total income, all is fair. However, most tax credits and deductions don't actually use AGI. They use a modified AGI.
What Is Modified Adjusted Gross Income (MAGI)?
Modified Adjusted Gross Income (MAGI) does not appear on your tax return. It is calculated from your AGI by adding some types of income to AGI. Thus, MAGI is sometimes slightly higher than AGI, but it's rarely dramatically higher than AGI.
The following income is added to AGI:
- Untaxed foreign income
- Non-taxable Social Security benefits (but not Supplemental Security Income or SSI)
- Tax-exempt interest (i.e. muni bonds)
Uses of MAGI
MAGI is used to determine your eligibility for the student loan deduction, child tax credit, deductibility of IRA contributions, ability to contribute directly to a Roth IRA, IRMAA subsidies, additional PPACA taxes, and PPACA premium subsidies. Despite not appearing on your tax return, it seems to be used far more frequently than AGI when determining eligibility.
More information here:
The 1 (Weird) Tax Trick the IRS Hates
Taxable Income
Taxable income is simply line 15 of the 2023 Form 1040. To get there, you subtract your “below the line” deductions from your AGI. Below the line deductions are EITHER the standard deduction OR the itemized deductions listed on Schedule A, which are mostly:
- Property and income taxes (up to $10,000),
- Mortgage interest, and
- Charitable contributions
You also get to subtract the Qualified Business Income (QBI or 199A) deduction, which is a major deduction for many of us, from your AGI before you get your taxable income.
Uses of Taxable Income
Once you have your taxable income, you can calculate the tax due using a table; manual calculations; or, more likely, tax software. Tax credits and prior payments and withholdings then reduce that tax bill until you determine the amount you need to settle up with the IRS as a payment or a refund. Rarely, your taxable income is used to determine your eligibility or the size of a given tax benefit. Mostly, taxable income just determines your tax bill and tax bracket (marginal tax rate).
Understanding the various types of income is an important aspect of financial literacy—even if the information is only rarely actionable.
If you need help with tax preparation or you’re looking for tips on the best tax strategies, hire a WCI-vetted professional to help you figure it out.
What do you think? What other uses for total income, AGI, MAGI, and taxable income did I miss?
I think the comment I would make about MAGI is that there is no single kind of MAGI like there is for AGI or Total Income. For instance, MAGI for determining whether or not you are subject to NIIT adds back the FEIE (untaxed foreign income) to AGI but not nontaxable interest, while MAGI for determining Medicare premiums adds nontaxable interest to AGI but not FEIE, and MAGI for the Marketplace healthcare plan subsidies and Medicaid eligibility adds back FEIE, non-taxable Social Security benefits, and tax-exempt interest. The calculation of MAGI depends on what the purpose is for making the modification to AGI.
Excellent point.
Agree with ParmmedMD. I was going to post the same point. For example, the Social Security Administration says that you don’t add untaxed Social Security Income to AGI to calculate your MAGI and IRMAA premium; you only add your tax-exempt income.
See
https://secure.ssa.gov/poms.nsf/lnx/0601101010
great post, but then was curious what the answer to his original issue was: “I got tripped up last year thinking that traditional IRA contributions made pre-tax are fully deductible.”
“Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If during the year either the taxpayer or the taxpayer’s spouse was covered by a retirement plan at work, the deduction may be reduced, or phased out, until it is eliminated, depending on filing status and income. (If neither the taxpayer nor the spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply.) Here are the phase‑out ranges for 2024:
For single taxpayers covered by a workplace retirement plan, the phase-out range is increased to between $77,000 and $87,000, up from between $73,000 and $83,000.
For married couples filing jointly, if the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is increased to between $123,000 and $143,000, up from between $116,000 and $136,000.”
https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000
The 2017 Tax Cuts and Jobs Act (TCJA) eliminated the alimony tax deduction for divorce agreements finalized after December 31, 2018. If executed on or before this date, the payments are still deductible. That’s why they ask for the date on the 1040. My understanding is that agreements executed before this date but modified after can either be deductible or not, depending on the exact phrasing – I would suggest consulting your attorney or accountant about this.
Unlike other aspects of the TCJA, which expire at the end of 2025 (unless they get extended), the elimination of the alimony tax was permanent.
As to the reasoning behind this change, there was apparently a “tax gap” created by a mismatch between what was being deducted by the contributor and what was claimed by the recipient. Too many recipients were not claiming the payment as income, so the government was losing money.
Thanks for sharing! Great comment.
Please comment on the effects of interest, dividends and capital gains in taxable accounts on AGI versus MAGI. It can be confusing and is important if you are near the “cliff” for IRRMA or the ACA calculations.
Well, AGI is easy. It all counts toward AGI unless it’s in a retirement account. But there are different MAGIs so that’s a little more complicated. But most interest, dividends, and capital gains are included in all the MAGIs too. One exception I believe is muni bond interest doesn’t go into AGI but does into at least one MAGI.
I got tripped up once because I made a large contribution to a DAF and used that deduction to allow me to make a larger than usual Roth conversion. That worked quite nicely to reduce my taxable income on my federal return. Unfortunately, I didn’t realize that my state taxes were based on my AGI, which didn’t take into account the large charitable contribution. Needless to say, my state tax bill was outrageous that year.
Every state has a different tax code. I actually get to use very few of my itemized deductions in Utah due to an income phaseout thing.
@WCI
While the description of Total Income: “Basically, all of the income you have that gets taxed is your total income and ends up on line 9.” is probably about the best you can do, the below quote is really stretching it when you try to say how you can use it:
“It could be used by a landlord or lender looking for your gross income. You’d use it on your personal income sheet or budget, but that’s about it.”
I would never use Total Income in my budget without adding back into it all the items that aren’t taxed, which can be significant. Even in my own simple retirement case these items can be:
Tax-exempt interest
Non-taxable IRA distributions
Roth distributions
Non-taxable portions of pensions or annuities
Non-taxable portion of Social Security
Thanks for sharing your insight. I suppose military people could add back in their BAH and BAS too.
“Thanks for sharing your insight.”
The McKinsey consultants polishing your blog article comments is showing through a bit!
Ha ha. No consultants, but I have learned it’s best to be nice over the years. FinancialDave comments often, usually with in-depth comments like this one. He’s a pretty bright guy who loves to spend some time in the weeds. We don’t always agree on everything, but his corrections are usually accurate.