Taxable Income: What It Is and How To Calculate It
In a perfect world, the income you receive would be all yours to keep. However, the tax man is on his way and any dollar you earn is subject to a tax bill. But what is taxable income? Is it everything you earn? Taxable income is the portion of your gross income, both unearned and earned income, that the IRS deems subject to taxes. Read on to learn more.
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What Is Taxable Income?
All income is taxable unless the tax code contains a specific provision that exempts it or allows it to be offset by deductions. Unless you can point to a tax code section that states certain income isn’t included in your taxable income, the income is considered taxable.
How To Calculate Taxable Income
Here are a few steps you can take to calculate your taxable income:
Figure out your filing status: How you file your individual tax return — as a single filer, head of household, married filing jointly or married filing separately — is an important aspect that will impact both your state and federal income tax returns.
Have all of your income documents included before you file your taxes: Income documents can include Form W-2, 1099-NEC, Form 1099-MISC or Form 1099-INT.
Calculate your adjusted gross income, or AGI: Some items are considered “above the line” as they reduce your income before you can include them in your itemized deductions, tax credits or standard deductions when you file. Examples include IRAs, health savings accounts, student loan interest and more.
Check your standard deductions: Standard deductions include what you can claim when you don’t have enough itemized deductions to claim. For the 2023 tax year single filers can claim a $13,850 standard deduction, heads of household can claim a $20,800 standard deduction or if you are married filing jointly, you can claim a $27,700 standard deduction.
Check your itemized deductions: These can include property taxes, mortgage interest paid, state and local taxes paid, charitable contributions, educational or student loan expenses, certain business expenses or unreimbursed medical bills.
Calculate your taxable income: To figure this out, you take your AGI and subtract all of your qualifying deductions.
Examples of Taxable Income
What is considered taxable income? Here are some of the most common examples.
Wages, Salaries and Bonuses
This includes income that you’re entitled to receive yourself. It can be in the form of wages, royalties, dividends, interest or commission.
Freelance Income
You have to file an income tax return on freelance income if your net earnings for the year were $400 or more. Your annual income should be reported on Form 1099-MISC, Miscellaneous Income, which reports payments made to people who are not employees.
Tips
Tips — whether cash or noncash (tickets, passes or other items) — are considered income and are therefore subject to income taxes. In order to report your tip income correctly:
Keep a daily tip record.
Report tips to your employer.
Report tips on your income tax return.
You can keep a daily tip record using Form 4070A, or any method you choose. Use Form 4070 to report tips to your employer, and report tips to the IRS using your regular income tax form. Tips are included with your other wages and salary on line 1 of Form 1040.
Investment Income
Any gains you make from investments count as taxable income, though this income might be offset by deductions. For example, when you sell a stock, you don’t pay taxes on the entire sale price, just the amount in excess of your basis — the amount you paid for the stock.
Similarly, rental income from investment properties can be offset by rental-related deductions such as depreciation and repairs. Investments include traditional investments, like stocks, bonds, rental properties and bank accounts.
Barter Income
Just because you don’t use currency to facilitate your transactions doesn’t mean you aren’t generating income. Any time that you receive goods or services in exchange for goods and services you provide, you are generating taxable income equal to the fair market value of what you receive.
Most Fringe Benefits
Fringe benefits refer to noncash compensation you receive for working, such as meals, a free car or season tickets to a sports team. Unless specially exempted, the fair market value of these benefits are included in your taxable income. Some fringe benefits are exempted from taxable income, such as the value of employer-provided health insurance, and others are exempt if they are of a very small amount and provided on an infrequent basis.
Money From Retirement Accounts
Just because you’re no longer working doesn’t mean you don’t have taxable income. Distributions from tax-deferred retirement investment accounts — including traditional IRAs, 401(k)s and 403(b)s — all count as taxable income.
Social Security
Your Social Security benefits might be taxable. The percentage of your Social Security income that’s taxable depends on your overall income.
What Is Nontaxable Income?
Types of nontaxable income include the following:
Child support payments: Child support that you receive does not have to be included in your taxable income for the year. In addition, if you pay child support, you cannot deduct that amount from your taxable income on your income tax return.
Qualified Roth account distributions: When you take qualified distributions from your Roth account, such as a Roth IRA or Roth 401(k), the distributions, including any earnings, come out tax-free.
Gifts received: Though not all gifts can be taxed, the gift tax limit for 2023 was $17,000 and is $18,000 in 2024. Anything you’ve given over this for the tax year 2023 will have to be filed for in 2024. You usually only pay gift tax on the amounts that exceed the allotted lifetime gift tax exclusion, which was $12.92 million in 2023 and $13.61 million in 2024.
Inheritances: You do not have to pay income taxes merely because you inherited assets upon someone else’s death. But, any subsequent gains count as taxable income. Certain assets, such as distributions from traditional IRAs and 401(k) plans, generate income that you are required to report as taxable income.
Final Take To GO
Being audited by the IRS probably ranks as high as getting a cavity drilled on most people’s list of fun things to do. By keeping accurate records of your income and knowing how to determine taxable income, you minimize your chances of being audited. Of course, you also don’t want to pay any more taxes than you’re legally required to, so knowing what you don’t have to include can be equally valuable.
FAQ
Here are the answers to some of the most frequently asked questions regarding taxable income.
What is considered taxable income?
Taxable income includes all income not specifically exempted by the tax code. It can include wages, salaries, bonuses, freelance income, tips, investment income and more.
What is the difference between income and taxable income?
Income is all the money you earn or receive in a year but not all of it is taxable. Taxable income is the portion of your income that is subject to income tax after exemptions and deductions.
What is taxable income on a W-2?
Taxable income on a W-2 would include wages, salaries, bonuses and more paid by an employer before any deductions are taken out. You will need to find your gross income for the W-2 form.
Gabrielle Olya and Michael Keenan contributed to the reporting for this article.
Information is accurate as of Feb. 29, 2024.
This article originally appeared on GOBankingRates.com: Taxable Income: What It Is and How To Calculate It
