What Is Taxable Income?

Taxable income is the portion of your income that the IRS uses to calculate how much federal income tax you owe. The same is true of state-level taxable income, except state taxes are the main focus in this case. Taxable income includes wages, salaries, bonuses, tips, business income, investment gains and other types of earnings. It also has subtracted from it any deductions, credits or other adjustments you may claim. Not all money you receive is taxable, and not every deduction reduces taxable income in the same way. So if you have questions about taxes and how to plan for them, you may want to speak with a financial advisor.

Understanding Taxable Income

Taxable income is essentially any money someone has received that’s subject to income tax. It’s calculated by first taking your gross income, which is the total amount of money that you’ve gotten from any source of income during the given tax year. Then you would reduce that amount by subtracting any deductions, credits and exemptions that you can claim. Although they’re sometimes confused for one another, taxable income differs from adjusted gross income (AGI). AGI, on the other hand, is your gross income minus all of your above-the-line tax deductions.

While there are multiple types of income, they can be divided into two broad categories: earned income and unearned income. Earned income is the money you make from traditional sources, like working as an employee or running your own company, and it is almost always taxable. Unearned income, on the other hand, may or may not be taxable, depending upon the specifics of the scenario at hand.

What Counts as Taxable Earned Income?

Examples of earned income that can be taxed include salaries, wages, commissions and any tips you receive from working at a restaurant or another business in the service industry. Other forms of employee compensation, such as paid time off, stipends and sick pay, are considered both earned income and taxable income. Self-employment income, rental income, long-term disability benefits (prior to the minimum retirement age) and union strike benefits are taxable.

The pay you receive from serving on a jury is subject to income tax, too. Usually, this money gets turned over to a worker’s employer. But the employee can get a tax deduction for the full amount of jury duty pay. This is an above-the-line deduction that you can claim on your tax return regardless of whether you’re itemizing your deductions or taking the standard deduction.

What Types of Unearned Income Are Taxable?

Many forms of unearned income are taxable. Unemployment benefits, alimony and gambling and contest winnings are all examples of unearned income that can be taxed. Other types of unearned income that can raise your income tax bill include dividends, any interest you earn from investing and capital gains.

If some of your debt has been forgiven, it’s generally taxable unless it was discharged through insolvency or bankruptcy. Life insurance proceeds are taxable as well if you exchange them for cash and take more money than the original policy amount.

If you receive Social Security, part of your monthly checks may be taxable. That may happen if you’re retired, your income comes from more than one source and the amount of money you’re receiving is higher than a certain threshold. If you have multiple streams of income, up to 85% of your Social Security benefits may be taxed.

What Unearned Income Isn’t Taxable?

Unlike earned income, unearned income is never subject to payroll taxes. In most cases, you won’t have to pay income taxes either if you have welfare benefits, you’re making child support payments or you’re receiving workers compensation benefits. Tax refunds, personal injury rewards and gifts generally aren’t taxable either (unless the gift itself generates income).

Scholarships aren’t considered taxable income unless you’re using the funds to cover the cost of certain expenses, like room and board. Inherited assets aren’t taxable unless the original owner would have had to pay income taxes. For example, if you inherited a 401(k), you’ll owe income taxes when you begin withdrawing money from the account.

Bottom Line

If you have multiple sources of income, it’s important to know which kinds of income are taxable. By understanding how these distinctions and their subsequent calculations are made, you can better prepare for tax season each year. Taxes can also change quite a bit based on the federal government, so understanding who’s tax plan and what laws you’re operating under at any given point in time is also crucial.

Tips for Tax Planning

Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re a high-earner, there are certain tax strategies that may be more viable for you than others. Take a look at our high-net-worth tax planning guide to learn more.