Many tax breaks are reserved for taxpayers whose income is below certain thresholds. In defining who can claim a particular credit or deduction, the IRS often refers to modified adjusted gross income or MAGI. Although the specific calculation of modified adjusted gross income varies depending on the situation, the basic mechanics of how MAGI works are quite simple. In some cases, the slight variation between modified adjusted gross income and regular adjusted gross income or AGI can make all the difference in helping you save thousands of dollars on your tax return.

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MAGI vs. AGI

To understand modified adjusted gross income, you first have to know about adjusted gross income. To calculate your AGI, you first start with your income from all sources, including work, investment income, self-employment income, taxable pension and retirement plan distributions, and a host of other, less common sources. Then, you reduce that income by allowable adjustments. Among those reductions are:

  • Contributions to tax-favored accounts, including traditional IRAs, health savings accounts, and self-employed retirement plans
  • Self-employment expenses for health insurance and half of the self-employment tax
  • Education-related expenses such as the tuition and fees deduction, student loan interest deduction, and deduction for educator expenses
  • Miscellaneous provisions such as moving expenses, bank early withdrawal penalties, alimony payments, and business expenses for certain reservists and performing artists

The result is the adjusted gross income. That number is the starting point for determining eligibility for many tax breaks, but some provisions require modifying that number somewhat. In those cases, what will be important is modified adjusted gross income rather than the plain-vanilla AGI.

What do modifications look like?

The modifications made to determine MAGI are different depending on the tax break claimed. An exhaustive list would be too long to include, but a few examples will show you several typical alternatives.

  • For purposes of determining whether you can deduct IRA contributions, you have to add back in any previously deducted amount for student loan interest or tuition and fees that you used to reduce your total income. In addition, you have to add normally nontaxable foreign earned income and housing exclusions or deductions, along with savings bond interest and employer-provided adoption benefits.
  • By contrast, for purposes of determining eligibility to contribute to a Coverdell Education Savings Account, only the foreign earned income and housing amounts have to get added back in, along with any income excluded by residents of Puerto Rico or American Samoa.
  • Often, the MAGI will be AGI increased by the amount of the tax break for which the MAGI applies. For instance, with student loan interest, eligibility is determined by reference to AGI excluding any amount of student loan interest paid. This prevents any confusion from circular definitions.

Modified adjusted gross income confuses many people, and it can require worksheets or other long computations to figure out MAGI. However, the general idea is to make sure that tax breaks go to the people who were intended to receive them. That's why it's important to understand MAGI -- and why it's worth it to take the time to figure it out.

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