What is Taxable Income?

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Table of Contents

What is Taxable Income?

Taxable income is the portion of total income (earned and unearned) that is used to determine how much tax an individual or company owes to the government. Income can be received in the form of money, property, or services, according to the IRS. 

It is related to “adjusted gross income” or AGI. If you take your AGI and subtract deductions and exemptions, you will arrive at taxable income.

Why Does Taxable Income Matter?

Taxable income matters when determining the total amount of income that is subject to a tax liability. You need to know what is considered taxable income, what is considered nontaxable income, how to calculate taxable income, and how to minimize it.

By knowing the ins and outs of taxable income you can efficiently and correctly estimate and file your taxes.

Taxable Income and Nontaxable Income

The counterpart to taxable income is nontaxable income. As the name would imply, nontaxable income includes income streams that are not considered for taxation. You’ll want to know the difference between the two.

Taxable Income

The following list of items are considered taxable income:

  • Wages
  • Salaries
  • Tips
  • Self-employment income
  • Union strike benefits
  • Long-term disability benefits
  • Severance pay
  • Real estate income
  • Unemployment benefits
  • Capital gains
  • Alimony
  • Interest and dividends

Nontaxable Income

Now we have a list of nontaxable income items:

  • Alimony payments
  • Municipal bond earnings
  • Cash rebates on items you purchase from a retailer, manufacturer, or dealer
  • Child support payments
  • Disaster relief earnings
  • Gifts and inheritances
  • Refund from federal taxes
  • Reimbursements from qualifying adoptions
  • Most healthcare benefits
  • Welfare payment
  • Workers compensation

Earned and Unearned Income

Your income is comprised of two types: earned and unearned income. The two come with their own unique tax implications.

Earned Income

Earned income is income received from working and also income from disability payments.

The list includes:

  • Wages
  • Salaries
  • Tips
  • Self-employment income
  • Union strike benefits
  • Long-term disability benefits

Unearned Income

The counterpart to earned income is unearned income. This is income that you did not earn through working for it.

The list includes:

  • Annuity payments
  • Pension income
  • Distribution from retirement accounts
  • Capital gains
  • Interest income
  • Dividends
  • Real estate income
  • Alimony
  • Unemployment compensation
  • Certain taxable social security benefits

It is important to note that…

  1. Earned income and unearned income are taxed at different rates
  2. The different types of unearned income are also taxed differently

Example For Earned and Unearned Income

Imagine you make $50,000 per year as an accountant. You also rent out another unit of your home for $1,000 per month. On top of this, you invest your money  in your spare time. Let’s say you did pretty good and earned $20,000 from your investments.

In this example, your earned income for the year would be $50,000.

You unearned income would be ($1,000 x 12) + $20,000 = $32,000

Gross Income vs Taxable Income

Gross income and taxable income are sometimes confused.

Gross income is all income you have received that isn’t exempt from taxation.

Taxable income is the portion of gross income that is actually subject to being taxed.

Taking your gross income and subtracting deductions and exemptions will help you arrive at taxable income.

How to Calculate Taxable Income

The calculation of taxable income is not so straightforward. Your total taxable income depends on several factors including your filing status, standard deduction size, and other deductions and exemptions.

Here are the general steps:

  1. Find your total income, including earned and unearned.
  2. Take your income amount and make adjustments (such as the standard tax deduction) to arrive at your adjusted gross income (AGI).
  3. Subtract all forms of deductions and exemptions you are entitled to by law.

You’ve arrived at taxable income. Now that you have your taxable income amount, you can calculate how much you will pay in Federal income taxes. You should refer to the current year’s tax brackets to see where you fall into.

Tax Brackets

A tax bracket, usually displayed in a table format, shows ranges of income and the Federal income tax rates those incomes are subject to. The U.S. follows a progressive tax system, which means that as an individual’s income grows, the percentage rate they are taxed at will grow too.

The tax brackets for 2019 currently and into 2020 range from 10% to 37%. The income ranges associated with the tax bracket is different depending on your filing status. Check out the table below, which was sourced from debt.org

When you look at the income amounts, understand that those amounts are for taxable income, not total income. If you are single and your salary is $100,000 per year and your taxable income is $70,000, you would fall into the 22% tax bracket.

This means income from $0-$9,700 will be taxed at 10%.

Income from $9,701-$39,475 will be taxed at 12%.

Income from $39,476-$84,200 will be taxed at 22%.

How to Reduce the Amount of Taxes You Pay

You can reduce your taxes through tax credits and deductions.

A tax deduction is a deduction that lowers one’s taxable income and therefore lowers the amount of taxes owed.

Some common tax deductions include…

  • Charitable contributions
  • Sales tax deduction
  • Home office deduction
  • Student loan interest
  • Mortgage interest
  • Medical expenses
  • IRA contributions
  • Gambling losses

A tax credit is a credit that allows for a dollar for dollar reduction from your tax bill. 

Some common tax credits include…

  • American Opportunity tax credit
  • Lifetime Learning tax credit
  • Residential Energy tax credit
  • Low Income Housing tax credit
  • Savers tax credit

The two sound very similar, but just remember…

Tax deductions reduce your amount of taxable income. Tax credits reduce your total tax liability.

Summary

Taxes and tax lingo can be confusing. There are many related terms to know about and rules that apply to certain situations. This post scratched the surface on many topics that deserve their own in-depth post, but hopefully I helped you understand taxable income a little better than before you visited the site.

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Author: Brandon Hill

Brandon is the creator of Bizness Professionals and author behind each post. He is currently a working professional, primarily in finance, and looks to provide resources to aspiring or current young professionals for well-rounded professional and personal development. Find out more on the About page.

There may be affiliate links on this page, which means I may receive a small commission for any purchases made through links in this post. As an Amazon Associate, I earn from qualifying purchases. Products that are linked are ones I highly recommend and have used/tested myself.

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