What is taxable income?

Definition:

Taxable income is the income of an individual that is subject to income tax. Generally, all income must be reported, whether from wages or other sources, that is considered taxable on the tax return.

How does taxable income work?

Taxable income is the income on which income tax can be collected. This amount must be reported on the individual’s tax return during tax season.

For example, the following types of income are all considered taxable for federal income tax purposes:

• Business and self-employment income
• Capital gains
• Gambling winnings
• Most interest
• Pass-through income from partnerships
• Rental income
• Royalties
• Tips
• Unemployment compensation
• Wages, salaries, bonuses, and commissions

It is important to keep in mind that simply receiving a taxable income item during the year does not necessarily mean you have to pay taxes on it. You are allowed to deduct relevant adjustments and deductions from your taxable income when calculating your tax liability on your tax return, such as Form 1040 for federal income tax purposes.

Note: Sometimes, the term “taxable income” is used only to describe the income that the taxpayer owes. For example, on Form 1040 for federal income tax purposes, this amount of the taxpayer’s taxable income is calculated by taking the taxpayer’s total taxable income, then subtracting any income adjustments, the taxpayer’s standard deduction or itemized deductions, and qualified business income deduction if applicable.

Generally, for federal income tax purposes, all income received by the taxpayer is considered taxable income unless explicitly exempted from tax by the tax law in the Internal Revenue Code. Thus, all income received by citizens and residents of the United States is considered taxable income unless specified by the Internal Revenue Code that a particular income item is not taxable.

Other effective taxing authorities, such as state governments, impose their own income tax laws that determine whether a portion of income is taxable or not. This means that some of the taxpayer’s income may be taxable for federal income tax purposes and non-taxable for state income tax purposes, and vice versa.

For example, while unemployment compensation is generally taxable for federal income tax purposes, some states, like California, exempt unemployment compensation from state income tax.

On the other hand, while interest on municipal bonds is generally non-taxable for federal income tax purposes, only the interest on municipal bonds issued by local authorities in California is non-taxable for California income tax purposes. Interest on municipal bonds issued by local authorities outside California is taxable in California.

Taxable income vs. Non-taxable income

While taxable income is the income that is subject to tax, non-taxable income is the income that is not subject to tax because the relevant tax law states it is not taxable.

Note: Although non-taxable income is not subject to income tax, the recipient may still have to report it on their tax return. For example, if you qualify for a refund from a qualified adoption credit for a child, some of that may not be taxable, but it must be reported.

For federal income tax purposes, the following types of income are generally considered non-taxable:

• Child support
• Life insurance proceeds
• Gifts
• Inheritance
• Life insurance payouts
• Interest on municipal bonds
• Supplemental Security Income (SSI)

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Sometimes, whether an income item is taxable or not may depend on other components in the taxpayer’s tax return. For example, the taxpayer’s social security benefits may be taxable if half of their benefit amount, plus all their other taxable income, plus tax-exempt interest, exceeds a certain amount based on their tax filing status.

Frequently Asked Questions

What is your taxable income?

Taxable income is your gross income minus any deductions. Your gross income may come from wages, salaries, rental and royalty income, or investment and business income. Your deductions may vary depending on where and how you file your return but may include the standard deduction (for individuals) or business expenses (for filers).

How do you calculate taxable income?

Calculating taxable income is simple if you keep good financial records. Gather all the income you receive from every source (wages, investments, business income) to determine your gross income. Then subtract any deductions you may be entitled to. The result is your taxable income.

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Sources:

• IRS. “Form 1040 U.S. Individual Income Tax Return.”
• State of California Franchise Tax Board. “Unemployment Personal Income Types.”
• State of California Franchise Tax Board. “2022 Instructions for Schedule CA (540) California Adjustments.”
• IRS. “Publication 525, Taxable and Nontaxable Income.”
• IRS. “Social Security Income.”

Source: https://www.thebalancemoney.com/what-is-taxable-income-5214821