Taxable Income: What It Is and How To Calculate It

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In a perfect world, the income you receive would be all yours to keep. However, the tax man is on his way and any dollar you earn is subject to a tax bill. But what is taxable income? Is it everything you earn?

Taxable income is the portion of your gross income that the IRS deems subject to taxes. This includes:

• Unearned income, like rental earnings or dividends from investments
• Earned income, like W-2 wages or self-employment income

The way your income is taxed differs based on whether it’s considered earned or unearned . Read on to learn more.

What Counts as Taxable Income?

So, what is taxable income?

All income is taxable unless the tax code contains a specific provision that exempts it or allows it to be offset by deductions. Unless you can point to a tax code section that states certain income isn’t included in your taxable income, the income is considered taxable.

Key sources of taxable income include:

• Wages and salaries
• Investment income (including interest and dividends)
• Self-employment income
• Other sources (e.g., tips, bonuses and gambling winnings)

Wages and Salaries

Perhaps the most common type of taxable income is wages and salaries. This includes both hourly and salary earnings. You can find this information on a W-2 Form, as provided by your employer.

Commissions, fees and tips also fall under the IRS’s definition of “employee compensation” and are taxable.

Investment Income

Any gains you make from investments count as taxable income. However, this income might be offset by tax deductions or tax write-offs. 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. Alternative investments, like cryptocurrency, also count toward earned income.

If you earn capital gains or dividends, know that they’re also taxable. Ordinary dividends are taxable as ordinary income, while qualified dividends are taxed at lower capital gain rates. Capital gains are generally taxed at the regular income rate for your bracket, though it depends on whether those are short-term or long-term capital gains.

Note that interest is also taxable in the year you receive it, though some types are tax-exempt. Taxable interest includes interest on:

• Bank accounts
• Certificates of deposits (CDs)
• Savings bond
• Income from Treasury bills, notes and bonds

Self-Employment Income

Sometimes called “freelance income,” self-employment income is also taxable. 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. This form reports payments made to people who are not employees.

If you’re self-employed, you must file an annual income tax return, as well as pay estimated self-employment taxes quarterly. You may have to pay self-employment (SE) tax in addition to income tax. SE tax is a Medicare and Social Security tax for those who work for themselves (as opposed to a traditional employer).

Tips

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 of tips you received from customers or other employees.
• Report tips to your employer.
• Report tips on your income tax return.

You must report all received tips. Your employer should include any reported tips in box 1 of your W-2 Form.

You can keep a daily tip record using Form 4070A (Employee’s Daily Record of Tips), or any method you choose. If you do use Form 4070A, be sure to include:

• The date of entry
• Tips received (including credit and debit card tips)
• Tips paid out to other employees
• The names of the employees to whom you paid tips

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 lines 1 (cash tips total), 2 (credit and debit card tips total) and 3 (all tips paid out) of Form 1040.

Barter 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. 

An example of bartering income, as defined by the IRS, is when a plumber exchanges “plumbing services for the dental services of a dentist.”

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 a very small amount and provided on an infrequent basis.

Other Sources

Miscellaneous forms of income may also be taxable. This includes bonuses, awards, government cost-of-living allowances earned from living abroad (in some cases) and severance pay.

Some types of royalties, such as those gained from investments or business income, are also taxable income. The same goes for gambling winnings, including earnings from lotteries or raffles.

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, 401(k)s and 403(b)s — all count as taxable income.

For example, the money in your traditional IRA is only taxed after being distributed to you. These distributions are either partially or fully taxable in the year you receive them. On the other hand, Roth IRA distributions are not subject to taxation.

Social Security

Your Social Security benefits might be taxable. The percentage of your Social Security income that’s taxable depends on your overall income.

If you file a federal tax return as an individual, you could pay income tax on up to 50% of your Social Security benefits (assuming a combined income of $25,000 to $34,000). If your combined income is over $34,000, up to 85% of your total benefits could be taxable. The rules and limits for joint filers are slightly higher.

What Isn’t Taxable?

Income is generally subject to taxation unless otherwise exempted by law. Types of nontaxable income include the following:

• Child support payments: 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 401(k), the distributions, including any earnings, come out tax-free.
• Gifts received: Though not all gifts can be taxed, the gift tax limit for 2024 is $18,000 and is $19,000 in 2025. Anything you’ve given over this for the tax year 2024 will have to be filed for in 2025. You usually only pay gift tax on the amounts that exceed the allotted lifetime gift tax exclusion, which was $13.61 million in 2024 and will increase to $13.99 million in 2025.
• Inheritances: 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. Certain assets, such as distributions from traditional IRAs and 401(k) plans, generate income that you are required to report as taxable income.
• Life insurance payouts: When a loved one passes away and leaves their life insurance proceeds to you, this money isn’t generally taxed. If the proceeds generate interest, however, you may be required to report and pay taxes on it.
• Certain scholarships and grants: You typically won’t have to pay taxes on scholarships or grants, provided that money is used for a qualified academic program’s tuition, fees or other course-related expenses. This money may be subject to taxation if it represents “payment for your services.”

Certain niche situations exist in which earnings that would normally be taxed are actually exempt.

For example, interest may be nontaxable if it comes from bonds (Series EE or Series I) issued after 1989 and used to cover qualified higher educational expenses. Some awards, like Olympic or Paralympic medals, are also tax-exempt.

Note that you may still have to report your nontaxable income when filing taxes.

Deductions That Reduce Taxable Income

If your taxable income is high, don’t worry. There are ways to lower your taxable income.

One option is to take deductions — that is, expenses or losses incurred throughout the year — when you file taxes. These essentially reduce your income so you pay less than you would have. You’ll need to provide proof of the expenses or losses you wish to deduct.

Two main types of deductions exist:

• Standard deductions: Most taxpayers take the standard deduction, which varies based on your filing status. For the 2024 tax year, single filers can claim a $14,600 standard deduction, heads of household can claim a $21,900 standard deduction and married persons filing jointly can claim a $29,000 standard deduction. Individuals who are over 65, legally blind or a dependent on someone else’s tax return may have their own standard deduction.
• Itemized deductions: If you experienced greater losses or expenses than the standard deduction allows, you may want to itemize instead. This could lower your tax bill when it comes due. Be sure to keep detailed records of all expenses throughout the year.

Nonresidents and those who only paid taxes for part of the year won’t qualify for the standard deduction. They’ll need to itemize instead.

The following expenses can be used to lower your taxes, whether you go with the standard deduction or itemize:

• IRA contributions
• Alimony
• Health Savings Account contributions
• Student loan interest payments
• Teacher expenses
• Business use of your home or car
• Early withdrawal penalties you’ve paid
• Certain work-related education expenses (primarily for those who are self-employed, military, government or have a qualifying disability)
• Moving expenses (military personnel only)

If you itemize your deductions, you can also deduct the following:

• Capital losses
• Gambling losses
• Mortgage interest
• Charitable donations
• Bad debts
• Canceled mortgage debt
• Medical expenses over 7.5% of your adjusted gross income
• Losses from qualifying theft or disaster
• Certain types of taxes (e.g., income, personal property, sales and real estate)

If you qualify for certain tax credits, you could also reduce how much you owe [24]. Common tax credits include the Earned Income Tax Credit (EITC) and the Child Tax Credit.

How To Calculate Taxable Income

Here are a few steps you can take to calculate your taxable income: 

1. Figure out your filing status: How you file your individual tax return — as a single filer, head of household, married filing jointly or married filing separately — is an important aspect that will impact both your state and federal income tax returns.
2. Have all of your income documents included before you file your taxes: Income documents can include Form W-2, 1099-NEC, Form 1099-MISC or Form 1099-INT.
3. Add up all your income: Calculate your adjusted gross income, or AGI. Some items are considered “above the line” as they reduce your income before you can include them in your itemized deductions, tax credits or standard deductions when you file. Examples include IRAs, health savings accounts, student loan interest and more.
4. Subtract nontaxable income: Separate your taxable and nontaxable income. When in doubt, consult a tax professional or review the IRS website for what counts as each type of income.
5. Decide which deduction to take: Standard deductions include what you can claim when you don’t have enough itemized deductions to claim. Itemized deductions can include property taxes, mortgage interest paid, state and local taxes paid, charitable contributions, educational or student loan expenses, certain business expenses or unreimbursed medical bills.
6. Calculate your taxable income: To figure this out, you take your AGI and subtract all of your qualifying deductions. Or use a tax filing software to calculate the deductions for you.

Final Take To GO

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. You may want to familiarize yourself with the IRS’s guidelines for taxable and nontaxable income. Alternatively, you can use a tax filing software or speak with a professional about the best ways to lower your tax bill — and possibly get a larger refund.

Angela Mae, Gabrielle Olya and Michael Keenan contributed to the reporting for this article.

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