As a small business owner, taxes can feel like an endless maze of forms, calculations, and regulations. And one of the most confusing parts is something called modified adjusted gross income — or MAGI.
If you don’t calculate MAGI properly, you could miss out on tax deductions and credits that save you major money. You’ll also need to be familiar with the concept to answer employees’ questions and give them the information they need around tax season.
The good news is that understanding MAGI doesn’t have to be complicated. We’ll break down everything you need to know about modified adjusted gross income, so you can feel confident you’re filing correctly and leveraging tax savings — and be ready to answer any questions from your team.
What is MAGI?
Modified adjusted gross income is an important Internal Revenue Service (IRS) tax calculation that determines your eligibility for certain deductions, credits, contributions, and more.
Let’s start by looking at adjusted gross income (AGI) before getting to the “modified” part.
AGI is your total taxable income minus above-the-line deductions, like student loan interest you’ve paid or your health savings account (HSA) deductions.
Your modified adjusted gross income is your AGI with certain items added back in. To turn AGI into MAGI, you need to add in certain types of income you previously deducted, like tax-exempt income from interest or muni bonds, excluded contributions to an individual retirement account (IRA), and excluded foreign earned income.
MAGI gives the IRS a clear picture of the actual income available to you in a given year before certain deductions or exemptions are applied. They use this number to decide on accurate thresholds for different tax credits and benefits.
For many people, MAGI is the same as AGI, but that’s not always the case so it’s important to make sure you’re calculating MAGI correctly.
Why is MAGI important for small business owners?
As a small business owner, paying close attention to your MAGI situation is vital.
If you’re a sole proprietor or pass-through entity without corporate taxation, your business income passes straight to your personal tax return, which means thresholds for deductions based on student loans and retirement contributions are linked to your personal MAGI figure.
For example, your MAGI can be used to determine what percentage of your retirement contribution is tax-deductible.
If you have a workplace retirement plan, like a 401(k), you can only claim certain deductions for your contributions to a traditional individual retirement account, based on your MAGI.
Here’s what that looks like for a single individual (or head-of-household filer) in 2023.
- MAGI of $68,000 or less: You can deduct the full amount of your IRA contributions
- MAGI between $68,000–$78,000: You can deduct a reduced amount.
- MAGI of $78,000 or more: You can’t deduct IRA contributions.
If you don’t accurately calculate your MAGI, you could end up over-contributing to IRAs or claiming credits and deductions you don’t qualify for, which could land you with fines and interest charges.
Aside from IRA contributions, AGI and MAGI affect other factors, including:
- Whether you can claim student loan interest deductions
- Whether you’re subject to net investment income tax (NIIT)
- Eligibility for certain child tax credits and adoption credits
- Eligibility for healthcare deductions and/or income-based assistance programs like Medicare, as well as premiums for Medicare Part B and prescription drugs
Small business owners need to be aware of MAGI to make informed decisions, plan their taxes, and make sure they’re claiming the right deductions and benefits.
While employers aren’t responsible for calculating MAGI for employees, understanding the concept can help you answer your team’s questions and provide them with the right information to make their own calculations. You’ll likely need to give your people records of gross wages paid, health insurance contributions, retirement plan contributions, and reimbursed business expenses.
That’s where a full-service payroll tool can save you time while keeping you compliant with labor laws. Homebase calculates payroll directly based on timesheets and sends the correct payment records to employees, your state, and the IRS. You can use Homebase to automatically process tax filings and issue 1099s and W-2s so you and your people have everything you need to file with ease.
How to calculate MAGI, step by step
Use these three steps to make MAGI calculations simple — and make sure you don’t miss anything.
1. Calculate your adjusted gross income
Remember, your AGI is your total taxable income minus above-the-line deductions. So first you need to know your total income.
This includes revenue sources like:
- Net business income
- Capital gains
- Taxable portfolio income (interest, dividends, etc)
- Rental real estate income
- Any other taxable income
Add all of these up to determine your total taxable income for the year.
Then, subtract any above-the-line deductions like:
- Half of self-employment taxes paid
- Health savings account contributions
- Retirement account contributions
- Student loan interest paid
- Alimony payments
What’s left is your adjusted gross income or AGI.
2. Add back certain excluded income to your AGI
For your MAGI, you have to add back in certain income that was excluded from your AGI.
- Foreign earned income
- Foreign housing
- Tax-exempt interest on state and municipal bonds
- IRA contributions
Add back any of these items that apply to you to get your MAGI.
3. Check your MAGI against current thresholds
Once you’ve calculated your MAGI for the tax year, cross-reference the number against the current thresholds to see how it impacts your deductions, credits, contribution limits, and exemptions. These differ depending on whether you’re a single filer or file jointly with a spouse, as well as other factors, so you’ll need to look at how the regulations apply in your particular case.
Pay particular attention to the most recent guidance on:
- MAGI-based deduction limits for individual retirement accounts (where the filer also has a workplace retirement plan)
- MAGI cutoffs for claiming student loan interest
- MAGI thresholds for Medicare and other health program eligibility
- MAGI brackets that determine whether you pay net investment income tax (NIIT)
If your MAGI falls within the eligibility range for certain credits and deductions, be sure to claim them. If your income exceeds the MAGI limits set, make sure you remove any relevant contributions — or decrease them to the allowed amount — before filing, so you avoid penalties.
Staying on top of modified adjusted gross income
Understanding how MAGI works and how to calculate it empowers small business owners to file their own taxes and provide relevant information to their employees.
But digging through spreadsheets and manually calculating payroll is a stressful, time-consuming process.
With Homebase, you’ll have clear records of your own income details and be able to provide your people with all the information they need to calculate MAGI and file their taxes. Homebase automates tax reporting and generates the W-2/1099 forms you need for both employees and contractors.
What’s more, you can use the Homebase time clock to build out accurate timesheets and integrate the data directly into payroll, avoiding manual errors in transferring figures.
Homebase’s payroll, compliance, and operational solutions can help your small business tackle calculations with confidence.
FAQs about MAGI for small business owners:
What is the difference between AGI and MAGI?
The difference between adjusted gross income (AGI) and modified adjusted gross income (MAGI) lies in how you calculate them and how they’re used.
You calculate AGI by starting with your taxable income and subtracting certain “above-the-line” deductions, like health savings account contributions and student loan interest paid.
MAGI is a modified version of AGI used to determine eligibility for certain tax benefits and to calculate taxable Social Security benefits.
You calculate MAGI by adding back certain deductions to AGI, such as student loan interest and half of the self-employment tax.
Does MAGI affect your IRA contributions?
Yes, your Modified Adjusted Gross Income (MAGI) does affect your Individual Retirement Account (IRA) contributions.
The Internal Revenue Service (IRS) uses MAGI to determine whether you qualify to contribute to a Roth IRA and whether you can deduct contributions to a traditional IRA if you have a 401(k). If your MAGI exceeds limits set by the IRS and you and/or your spouse have a retirement plan at work, you can’t deduct contributions when you file your tax return.
How does MAGI affect health insurance?
The Internal Revenue Service (IRS) uses MAGI to determine whether you qualify for certain healthcare waivers and incentives under the Affordable Care Act (ACA) for states’ health insurance marketplaces. MAGI is also used as a threshold for qualifying for state Medicaid programs.