In White v. United States, a Supreme Court case, Justice Stone stated that “every deduction from gross income is allowed as a matter of legislative grace, and only as there is clear provision therefor can any particular deduction be allowed.” In short, all income is taxable unless the tax code contains a specific provision that exempts it or allows it to be offset by deductions.
Though the Internal Revenue Service audited less than 1 percent of federal income tax returns filed for the 2015 tax year, you don’t want to give the IRS reasons to look at you. Learn the differences between taxable and nontaxable income so you can file correctly and prevent a tax audit.
What Is Taxable Income?
Unless you can point to a tax code section that states that certain income isn’t included in your taxable income, the income is considered taxable. Here are some of the most common examples of taxable income:
Wages, Salaries, and Bonuses
This includes income that you’re entitled to receive yourself, but you delay receiving it or direct it to be paid to someone else. For example, if you receive a paycheck on Dec. 29, 2017 but you delay cashing the check until January 3, 2018, it still counts as taxable income for the 2017 tax year. Similarly, if you perform work for an employer and ask the employer to write the check to your child, you must still report the income on your income tax return, even though your child received the check.
Any gains you make from investments count as taxable income, though this income might be offset by deductions. For example, when you sell a stock, you don’t pay taxes on the entire sale price, just the amount in excess of your basis — the amount you paid for the stock. Similarly, rental income from investment properties can be offset by rental-related deductions such as depreciation and repairs. Investments include traditional investments, like stocks, bonds, rental properties and bank accounts.
For example, the IRS imposes tax on savings account and checking account interest. It also includes investments in nontraditional assets like digital currencies. Income you receive through a business entity, such as a partnership, LLC or corporation is also considered taxable investment income.
Just because you don’t use currency to facilitate your transactions doesn’t mean you aren’t generating income. Any time that you receive goods or services in exchange for goods and services you provide, you are generating taxable income equal to the fair market value of what you receive. For example, if you agree to draft a legal document for someone in exchange for that person performing dental work on you, the value of that dental work must be included on your taxes as taxable income.
Most Fringe Benefits
Fringe benefits refer to non-cash compensation you receive for working, such as meals, a free car, or season tickets to a sports team. Unless specially exempted, the fair market value of these benefits are included in your taxable income. Some fringe benefits are exempted from taxable income, such as the value of employer-provided health insurance, and others are exempt if they are of very small amount and provided on an infrequent basis. For example, if your company pays for a company picnic every summer, you usually don’t have to include the value of the food you eat. However, if you get to order $10 of food from the cafeteria for lunch each day, you must include the value of the food in your taxable income.
Just because you’re no longer working doesn’t mean you don’t have taxable income. Distributions from tax-deferred retirement plans — including traditional IRAs, 401ks and 403bs — all count as taxable income. In addition, depending on your other income, up to 85 percent of your Social Security benefits might be taxable.
Alimony that you receive counts as taxable income to you. If you pay alimony, you are allowed to deduct that amount from your taxable income.
What Is Not Taxable Income?
Types of nontaxable income include the following:
Child support that you receive does not have to be included in your taxable income for the year. In addition, if you pay child support, you cannot deduct that amount from your taxable income on your income tax return.
Qualified Roth Account Distributions
When you take qualified distributions from your Roth account, such as a Roth IRA or Roth 401k, the distributions, including any earnings, come out tax-free.
You do not need to report as income gifts that you receive from someone else. But, if the donor does not pay any required gift tax, you might be liable for paying it. Once you receive the gift, any additional income generated is taxable to you. For example, if your parent gifts you stock and then a month later the stock pays the dividend, you report the dividend as taxable income on your tax return.
You do not have to pay income taxes merely because you inherited assets upon someone else’s death. But, any subsequent gains count as taxable income. For example, imagine that you inherited a house from your aunt that was worth $250,000 at the time of her death. If you hold the home for a year and then sell it for $260,000, you have $10,000 of taxable gain.
Certain assets, such as distributions from traditional IRAs and 401k plans, generate income that you does required to report as taxable income. For example, if you inherit a $100,000 traditional IRA from your dad at his death, you don’t have to pay tax on the account immediately. However, as you take money out of the IRA, that counts as taxable income to you in the same way it would have counted as taxable income to your father.
Why Reporting Taxable Income Correctly Matters
Being audited by the IRS probably ranks as high as getting a cavity drilled on most people’s list of fun things to do. By keeping accurate records of your income and knowing what is considered taxable income, you minimize your chances of being audited. Of course, you also don’t want to pay any more taxes than you’re legally required to, so knowing what you don’t have to include can be equally valuable.
Up Next: 8 Reasons You Could Get Audited