Taxable income is the base number used to calculate how much an individual or company owes the government in taxes for a given tax year. Since tax season is upon us, you may be wondering what you owe or will earn this year in taxes. You may have started a business, earned an advanced education certificate, or worked hard in your nine-to-five job this year. No matter how you’ve spent the past year, it’s normal to spend this time wondering if tax season will hurt or benefit your bank account. You may find yourself asking, “what will I owe this year?”
To understand what you may owe, you need to understand the basics of taxable income. This amount before tax is known as your gross income, which is what you earn without any deductions or exemptions allocated for a given year. Your gross income could come from your regular paycheck wage, salary, bonuses, tips, investment earnings, and any unearned income.
Understanding what taxable income is and how to plan for tax season can properly prepare your finances for what you may have to pay or what refunds you may receive.
What Is Taxable Income vs. Gross Income?
Taxable income, also known as adjusted gross income (AGI), is income you’ve earned that’s subject to taxes being taken out. Some examples of these earnings include money earned from your day job, bonuses, winning the lottery, or selling your house. Gross income is the amount of earnings you bring in, without any deductions taken out. For example, you may earn a monthly salary of $3,000 (your gross income) but only receive $2,000 (your income after tax and other deductions).
What Types of Income Must You Pay Taxes On?
Taxable income includes the paychecks you earn, but there are many other types of earnings that count as taxable income. The IRS counts taxable income from different sources, including your day job, to certain benefit bonuses and side hustles you may have.
- Wages, salaries, commissions, and tips (that fall into a certain tax bracket)
- Unemployment compensation
- Strike pay
- Rental earnings
- Alimony (for divorce decrees finalized during the year you’re being taxed in)
- Royalty payments
- Stock options, dividends, and interest
- Self-employment earnings
- Company-paid benefits: off-site gym membership, vehicle, tuition fees over a certain amount, dependent care, group life insurance over a certain amount, and financial counseling fees.
- Employer contributions to an unqualified retirement plan
- The fair market value of property received for services
- Disability retirement payments from an employer-paid program
- Sickness and injury payments from an employer-paid plan
- Property and services for which you exchanged
- Money and income from offshore accounts
- The remaining amount of a debt or loan that has been canceled or forgiven
What Types of Income Aren’t Taxed?
Non-taxable income is income you will not be taxed on whether or not you enter it in your tax return. Knowing what you should or shouldn’t include in your form reduces time spent finding receipts and paperwork. Income that won’t be taxed includes:
- Inheritances, gifts, and bequests
- Cash rebates on items you purchase from a retailer, manufacturer or dealer
- Alimony payments (for a divorce finalized in the past tax year)
- Child support payments
- Most healthcare benefits
- Reimbursed money from qualifying adoptions
- Welfare payments
How Do You Figure Out Your Taxable Income?
In the United States, taxes are dependent on which tax bracket you are in. This structured tax bracket system is what determines how much money you will owe for federal government taxes during that specific fiscal year. Depending on the bracket you fall into, it will impact the percentage you will owe from your income, budget, and overall financial plan.
There are currently seven different tax brackets within the federal tax code. To figure out which tax bracket you’re in, you’ll need to find out your taxable income (AGI) found on line 37 of Form 1040.
How Does Taxable Income Affect How Much I Owe?
The money you earn each year will determine the tax bracket you fall in, which, in turn, influences the tax rate you will owe on your earnings that given year. The more you earn each year, the higher the percentage you will owe due to the progressive rate. The lowest tax rate of 2019 is 10% and the highest is 37%.
How Does Taxable Income Affect My Refund?
The largest portion of taxes paid comes from the federal level. If you’re self-employed, experts recommend that you pay quarterly taxes throughout the year to avoid a large single payment at the end of the fiscal year. If you ended up paying more taxes than you should have in your tax bracket, you will be issued a refund. The more you paid, the bigger your refund will be.
How Can I Reduce My Taxable Income (Without Losing Money)?
Preparing for the tax season has its benefits. Scheduling your mortgage for the 31st of December to deduct your interest, taking care of all health-related treatments before the end of the quarter, and optimizing your tax deductions are a couple of examples to save money for the new tax year. Did you know that over 20% of Americans are eligible for deductions that they don’t use?
If you’re a student, you may be eligible for the American Opportunity Credit deduction, and if you work regularly, you may be eligible for the Earned Income Tax Credit, even if you’re single with no children. Knowing what deductions you’re eligible for can potentially help you earn up to hundreds, if not thousands, each tax season.
Frequently Asked Questions
Are Social Security Benefits Considered Taxable Income?
If you have another substantial source of income in addition to your social security benefits, you may have to pay federal income tax on your social security benefits. Each January, you should receive a benefit statement stating how much you earned the previous year. When you complete your federal income tax return, you will find out if you owe federal taxes in addition to any other source of income (if any). You have the option to have your taxes withheld monthly, quarterly, or pay in a lump sum at the end of the year.
Are Disability Insurance Payments Considered Taxable Income?
The tax you may or may not have to pay on your disability insurance depends on what types of benefits you receive, whether they were paid as before- or after-tax dollars, or if you or your employer paid these benefits for you.
If you paid for these benefits after your federal taxes were taken out of your paycheck, you may not owe income tax. Now, if you’re enrolled in a group disability insurance plan through your employer, the income tax will depend on who pays for the benefits. When paying for these benefits with your after-tax dollars, this income will be tax-free. If not, your income will count as taxable income.
Are Unemployment Benefits Considered Taxable Income?
Unemployment compensation is a source of taxable income. Towards the end of the year, you will receive a 1099-G that provides the total unemployment compensation you earned that year. If you decided not to pay quarterly or have taxes withheld on each payment, you will owe the IRS federal taxes on this source of income.
Are Inheritances Considered Taxable Income?
Inherited income is generally not taxable, but what you do with it may be. Any subsequent earnings on inherited assets are taxable unless they come from a tax-free source. Any gains from inherited dividends from stocks or property are normally taxable, but you can claim any losses on these sales. As some states may vary, check with your State’s Department of Revenue or speak with a tax professional.
Are Monetary Gifts Considered Taxable Income?
Gifts are generally not taxable. Those who give the gift will file for a gift tax return and pay any tax if needed, but most of the time they aren’t taxed unless the giver has provided over $11.2 million worth of gifts in their lifetime.
Are Gambling Winnings Taxable Income?
Money or merchandise prizes are fully taxable. Whether you won the lottery, a substantial raffle, or came home with your pockets full from the casino, you must report these earnings on your tax report. You may receive a 1099-MISC form from the place you got awarded your prize, or you will have to report your earnings to the IRS to be accounted for and taxed.
Are Bonuses, Tuition Reimbursements, and Other Benefits Taxable?
Any extra earnings such as bonuses, tips, and company cars are considered taxable income. As for tuition reimbursements, as long as they follow the requirements for the Education Working Condition Fringe Benefit Exclusion, this source of income is not taxed unless it surpasses $5,250.
Tax season can get a little stressful when you have multiple streams of income. Whether you’re a college student or a business owner, it’s helpful to properly plan for tax season to save your pretty pennies. Whether you want to look for ways to manage your finances to save money on taxes, or just want to know what deductions you qualify for, having control of your finances is power.
Treat your tax refund as a bonus and splurge on your grocery shopping, or check out our ways to trick yourself into spending less if you’re looking to save for this season’s tax payment.