In White v. United States, a Supreme Court case, Justice Harlan F. 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 2016 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, 2018, but you delay cashing the check until January 3, 2019, it still counts as taxable income for the 2018 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.
You have to file an income tax return on freelance income if your net earnings for the year were $400 or more. Your annual income should be reported on Form 1099-MISC, Miscellaneous Income, which reports payments made to people who are not employees.
Even if your net earnings were less than $400, you might still have to file an income tax return if you are married filing separately; owe any special taxes; received health savings account, Archer MSA or Medicare Advantage MSA distributions; had wages of $108.28 or more from a church or qualified church-controlled organization that is exempt from employer Social Security and Medicare taxes; received advanced payments of the premium tax credit or health coverage tax credit; or are required to include amounts in income under section 965, or have a net tax liability under section 965 that you are paying in installments under section 965(h) or deferred by making an election under section 965(i).
Tips — whether cash or noncash (tickets, passes or other items) — are considered income and are therefore subject to income taxes. In order to report your tip income correctly:
- Keep a daily tip record.
- Report tips to your employer.
- Report tips on your income tax return.
You can keep a daily tip record using Form 4070A, or any method you choose. Use Form 4070 to report tips to your employer, and report tips to the IRS using your regular income tax form. Tips are included with your other wages and salary on line 1 of Form 1040.
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 noncash 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.
Money From Retirement Accounts
Just because you’re no longer working doesn’t mean you don’t have taxable income. Distributions from tax-deferred retirement investment accounts — including traditional IRAs, 401ks and 403bs — all count as taxable income.
Up to 85 percent of your Social Security benefits might be taxable. The percentage of your Social Security income that’s taxable depends on your income. If you are a single filer whose income ranges from $25,000 to $34,000, you might have to pay income tax on up to 50 percent of your benefits, and if you make more than $34,000, you might have to pay income tax on up to 85 percent of your benefits. If you are a joint filer whose combined income ranges from $32,000 to $44,000, you might have to pay income tax on up to 50 percent of your benefits, and if you make more than $44,000, you might have to pay income tax on up to 85 percent of your benefits.
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. However, this is not applicable for 2019.
What Is Nontaxable 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 gifts that you receive from someone else as income. 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.
However, you might need to pay a tax if you are the giver of a gift, especially if it’s a transfer of property. However, the gifts you’d give in your everyday life are likely excluded from the gift tax. The annual exclusion for the gift tax applies to gifts of up to $15,000 for each recipient. Charitable donations are not taxable gifts and can be deducted from the value of other gifts made.
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 are 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 how to determine 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.
Click through to read more about the reasons you could get audited.
More on Taxes
- What Are Tax Allowances and How Many Should You Claim?
- TurboTax Free and Paid Options Review: File Accurate Returns Quickly
- These 15 Countries Pay More in Taxes Than Americans
- Watch: How to Legally Cheat Your Tax Bracket
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Gabrielle Olya contributed to the reporting for this article.