The answer to the "What is taxable income?" question is a bit more complicated than it might seem. You may think of your income as just your salary, but many of us receive money throughout the year from a variety of sources beyond a primary employer -- and while much of that income is taxable, some of it isn't.
Let's start answering the question above with some lists of taxable and non-taxable income.
Taxable income sources
Taxable income includes the following sources:
- Salaries, wages, bonuses, and tips
- Interest income (from bank accounts, CDs, most bonds, and so on)
- Dividend income
- Business income
- Capital gains
- Pensions and annuities
- Lump-sum distributions (say, from a retirement account)
- Rollovers from retirement plans
- Rental income and expenses, including security deposits
- Farming and fishing income
- Unemployment compensation
- Gambling income and losses
- Proceeds from sales
- Scholarships and fellowship grants (these are taxable if you're not pursuing a degree at an eligible school)
- Social Security benefits
- 401(k) plan income
- Income from stock options
- Certain canceled debts, including forgiven portions of credit card debt
- Alimony income
- Awards and prize money
- Income received, but not yet deposited, including checks not yet cashed
- Severance pay
- Jury duty fees
- Payment for services as an executor
- Payment for serving on a board of directors
- Money you steal and any other illegal income
Just because the categories above are taxable doesn't necessarily mean you'll be taxed on all of them. There are rules and exceptions related to many of the categories. For example:
- Capital gains are generally taxable, for example, but if you sell your home and meet certain requirements, $250,000 to $500,000 of your gain will not be taxed.
- Social Security benefits are taxable only if the beneficiary's income is above a certain level -- and even then only up to 50% or 85% of the benefits get taxed, depending on the income level.
- Gambling losses can be deducted, but you can't deduct more than you won. So winnings of $1,000 and a loss of 1,500 will only give you a $1,000 deduction. For any categories above that apply to you, learn more about their rules.
Non-taxable income sources
Not every kind of income is taxable. Below are some of the main kinds that qualify as non-taxable:
- Federal income tax refunds
- Child support payments
- Foster care payments
- Scholarships and fellowships (these are tax-free if you're pursuing a degree at an eligible school)
- Life insurance proceeds to a beneficiary
- Gifts and inheritances
- Some veteran benefits
- Some welfare payments
- Insurance reimbursements for medical expenses not previously deducted
- Compensatory damages for personal physical injury or illness
- Workers' compensation benefits
- Disability benefits from a policy you paid for (as opposed to a work-provided policy)
- Some qualified pension distributions for public safety officers
- Money rolled over from one retirement plan to another (if done according to the rules)
- Debts wiped out due to bankruptcy that are reported on a Form 1099-C
- Municipal bond income from bonds issued in your state
Just as with taxable income, there are rules that apply to many of the categories above, so it's smart to check out what rules apply to whatever income sources you have. With gifts, for example, the gift itself may not be taxable, but any income it produces is taxable. (Think of a bond that generates interest payments.)
Calculating taxable income
Your taxable income is not necessarily your total income, as your total income may well include non-taxable money. Even if your only income is a taxable salary, you won't be taxed on all of it. That's because, to arrive at your taxable income, you have to do a little adding and subtracting, per IRS rules. Here's the process:
Gross income - Adjustments = Adjusted Gross Income (AGI)
Adjusted Gross Income (AGI) - Exemptions - Deductions = Taxable Income
You first determine your gross income by adding up all your income for the year. Then you make adjustments by subtracting non-taxable income and exceptions to taxable income, such as contributions to qualified retirement accounts, alimony payments you made, qualifying moving expenses, qualified student loan interest paid, half of any self-employment taxes you paid, and any medical savings account deductions. That leaves you with your Adjusted Gross Income, or AGI, which is used to determine limitations on a number of tax issues, including exemptions, deductible IRA contributions, and itemized deductions.
You then claim your exemptions and make your deductions -- either taking an itemized deduction or a standard deduction -- whichever is greater. This leaves you with your taxable income. The taxes you ultimately pay each year are based on your taxable income, not your gross income or your AGI.
Knowing what taxable income is can help you come tax time.