This differs, however, from your modified adjusted gross income. To calculate your MAGI, it depends on why you are calculating it. Yes, I said, “it depends” — the key phrase when it comes to all things tax. The government has different calculations for MAGI, depending on what benefit or tax you are computing. They couldn’t make it easy. In essence, to calculate your MAGI, you have to add back certain items, which might include foreign income, foreign-housing deductions, student-loan deductions, IRA-contribution deductions, and deductions for higher-education costs, just to name a few.
How does your MAGI affect you? Let me provide three examples likely to affect you.
MAGI plays an important role in the formula used to determine how much of your Social Security benefit is taxable. For example, if your MAGI plus half of your Social Security benefit exceeds $25,000 for a single taxpayer ($32,000 for married filing jointly), up to 50 percent of your Social Security benefits may be subject to income tax. In this case, you should calculate your MAGI to include your adjusted gross income (including wages, interest, dividends, taxable pensions, and other sources), plus any tax-exempt interest income and income earned in a foreign country, U.S. possession, or Puerto Rico that is exempt from tax, further adjusted for some of the above the line deductions.
The Social Security Administration uses your MAGI to determine if you pay higher premiums on Medicare Part B and your Medicare prescription drug coverage. When determining this, the SSA calculates your MAGI as the total of your adjusted gross income plus your tax-exempt interest income. To make this more complicated, the SSA often uses the most recent tax return the IRS provides. For 2012, that could be your tax return filed in 2011, meaning the 2010 tax year. I plan to discuss this more next week.
Your MAGI will also factor into the 3.8 percent Medicare “surtax” on investment income for high income earners. The new surtax is 3.8 percent on the lesser of “net investment income” or the excess of your MAGI above the threshold amount. In this instance, MAGI is calculated by adding your net foreign earned income exclusion. Confusing? It certainly is. And that doesn’t even begin to calculate the surtax!
Depending on how your MAGI affects you, you may want to reduce your MAGI for 2012 by reducing your adjusted gross income: for example, by reducing self-employment income, reducing investment income, or creating above the line deductions, such as a deductible IRA contribution (if eligible). Likewise, you may be in a position where you may want to accelerate income in 2012 to avoid a higher MAGI in future years.
When it comes to MAGI, this is truly a case where the rules change depending on the players in the game. MAGI affects the taxes you pay in different ways, therefore it is best to consult a C.P.A. to help time the recognition of certain income for the most favorable tax treatment.