Small Business Taxes & Management^TM--Copyright 2019, A/N Group, Inc.

Introduction

Tax law is full of definitions. In some cases one definition of a word or term is all that's needed for all tax law. It appears that more frequently a word or term can have more than one definition, depending on the Code section. For individuals, there is gross income--that's all income subject to tax from whatever source (reduced by losses such as those from a rental property or sole proprietorship)--and adjusted gross income. Adjusted gross income is gross income increased or decreased by certain enumerated items such as the deduction for an IRA contribution and self-employed health insurance. Adjusted gross income is important because from it you deduct your standard or itemized deductions (and qualified business income deduction now) to arrive at your taxable income. It's also important because many benefits that are phased out, such as the ability to make contributions to a Roth, the child tax credit, etc. are based in some way on adjusted gross income. Unfortunately, many of these benefits are based on modified adjusted gross income or MAGI. And therein lies the issues. MAGI is computed differently for almost every phaseout.

Fortunately, tax software takes the different definitions into account. But that's also one of the reasons you shouldn't override any computations the program handles automatically. Because the computations are handled in tax software we won't go into details or even mention all the different definitions of MAGI, just some of the important and frequently encountered ones.

Traditional IRA Limit

If you're covered by a pension plan at work, your contribution to a traditional IRA are limited depending on whether you're single or married and only you or you and your spouse are covered by plans. (Contributions to a nondeductible IRA aren't restricted.) For the limitations for the current year, go to Tax Facts for Individuals. The modified adjusted gross income for this purpose is your AGI from Form 1040, line 7 before taking into account the IRA deduction and adding back:

1. any student loan interest
   
2. any domestic production activities deduction
   
3. any foreign earned income and/or housing exclusion (Form 2555)
   
4. any foreign housing deduction
   
5. any excludable savings bond interest
   
6. any excluded employer-provided adoption benefits (Form 8839)

Roth IRA Limit

In the case of a Roth IRA, there's no restriction based on pension plan coverage. Your contribution limit is based solely on modified adjusted gross income. But, much like a traditional IRA, the amount you can contribute is gradually reduced over a range after you reach the threshold. (See Tax Facts for Individuals for current year limits.) The computation is similar, but with a couple of twists. Start with your adjusted gross income from Form 1040, line 7 and subtract any income from the conversion of an IRA (other than a Roth) to a Roth IRA (included on Form 1040, line 4b) and a rollover from a qualified retirement plan to a Roth IRA (line 4b) then add back any items 1 through 6 from the add-backs for a traditional IRA and any traditional IRA deduction taken on Form 1040, line 32. That's generally your MAGI for the Roth contribution.

However, if you exceed the phaseout thresholds ($199,000 for married, joint and qualifying widow(er)s; $10,000 married filing separate; $135,000 all others; 2019 amounts) you still may be able to make a contribution if you have other income or loss items, such as social security income or passive activity losses that are subject to AGI-based phaseouts. In that case you can refigure your AGI solely for the purpose of figuring your modified AGI for Roth IRA purposes. Check IRS Publication 590-A for worksheets and information on how to refigure your AGI.

Rental Real Estate Losses

Rental is inherently a passive activity and passive activity losses are limited. They can be used to offset by passive activity income or, under a exception, a taxpayer can take up to $25,000 in passive losses from rental real estate if their MAGI is less than $100,000. If your MAGI is between $100,000 and $150,000 the $25,000 exception is phased out, $1 of exception for ever $2 your MAGI exceeds $100,000. The computation of MAGI is entirely different here from the limits on IRAs.

The starting point is the same, Form 1040, line 7, but you don't take into account:

1. Taxable amount of social security (or equivalent tier 1 railroad retirement benefits;
   
2. Deductible contributions to traditional IRAs and Sec. 501(c)(18) pension plans;
   
3. Exclusion of interest from Series EE and I U.S. savings bonds to pay higher educational expenses;
   
4. Exclusion oif amounts received from an employer's adoption assistance program;
   
5. Any passive activity income or loss incuded on form 8582;
   
6. Any renatl real estate loss allowed to real estate professionals;
   
7. Any overall loss from a publicly traded partnership;
   
8. Deduction allowed for one-half of self-employment tax;
   
9. Deduction for interest paid on student loans;
   
10. Domestic production activities deduction;
    
11. Deductiion for qualified tuition and related fees (currently expired; may be rnewed).

Social Security Benefits

Above a certain threshold 50 percent of your social security benefits are taxable; above a higher threshold, 85 percent are taxable. The computations here are different and they aren't based on AGI or a variation of it, but on total income. We won't go through the calculations because they're involved, but the income items that make up the calculation are:

• wages, interest, tax-exempt interest, dividends and IRAs, pensions, and annuities;
  
• income from Form 1040, Schedule 1, line 22 (additional income such as Schedule C icnome, capital gains, etc.:
  
• excluded adoption benefits:
  
• foreign income or housing excluded:
  
• certain income of bona fide residents of Puerto Rico or American Samoa.

Other Definitions

There are a number of other benefits or taxes that are based on modified adjusted gross income. They include the child tax credit, the adoption credit, student loan interest, interest exclusion for U.S. savings bonds used for education, American Opportunity Tax Credit, and the premium tax credit. Many have less adjustments to adjusted gross income, such as the net investment income tax. In that case the only adjustments are for the foreign earned income exclusion and the associated deductions related to the exclusion. If you're doing tax planning and either not entering all the data in a program or running the numbers by hand, be sure to check definitions.

--Last Update 04/24/19