Tax planning and compliance for investors
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Kaye A. Thomas
Updated April 9, 2011
Rules for determining your modified adjusted gross income for purposes of IRA contributions.
IRA owners need to know their modified adjusted gross income for various purposes:
Finding your modified AGI is a two-step process. First find your adjusted gross income, then apply the modifications.
This topic is covered in Chapter 13 of our book Go Roth!
Adjusted gross income ("AGI") represents your total income reduced by certain deductions known as "adjustments," but before you take your itemized deduction or standard deduction, and before you take the deduction for personal exemptions.
If you file regular Form 1040 or Form 1040A, adjusted gross income is the last number at the bottom of page 1 (and the first number at the top of page 2). On Form 1040EZ, adjusted gross income appears on line 4.
Q: Are capital gains included in AGI?
A: Yes. For example, if you have a $20,000 capital gain, it will increase your AGI (and your modified AGI) by $20,000. This is true even for long-term capital gains that are subject to special tax rates.
To estimate your adjusted gross income for a year that's not yet completed, it's usually best to begin with your adjusted gross income from the preceding year's tax return and estimate any changes from there.
Q: What if I contribute to a Roth IRA, and later find out that my modified AGI is too large?
A: You should be able to avoid penalties if you take appropriate action, which may involve a recharacterization in which.you move the contribution (as adjusted for earnings) to a traditional IRA, or a corrective distribution in which you withdraw the contribution.
To arrive at your modified AGI, start with your adjusted gross income and then add back the following items:
Note that you are not required to add back any contribution you made to an employer plan such as a 401k plan. If you are running up against the limit for modified AGI, one way to reduce that number is to make deductible contributions to an employer plan.
There's an additional modification that's made only when you're determining modified AGI for purposes of the Roth IRA. In this case you exclude any income you report as a result of converting a traditional IRA to a Roth IRA. Without his favorable rule, the income reported on the conversion could prevent you from making additional Roth IRA contributions.
Example: You're single and have a traditional IRA worth $120,000 with no basis. Before you decide to make a conversion your AGI and your modified AGI are both equal to $80,000. If you convert this IRA to a Roth IRA your AGI will increase to $200,000. But the conversion doesn't count as part of your modified AGI, so you can still make contributions to your Roth IRA.
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