Understanding the 3 Types of Income — Adjusted Gross, Modified Adjusted Gross, and Taxable Income

By Dr. Jim Dahle, WCI Founder

We 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? Comment below!

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