What is Taxable Income?
Taxable income is the portion of your annual earnings that is subject to taxes — Because of tax deductions, adjustments, and various exemptions, you usually don’t pay taxes on everything you earn.
🤔 Understanding taxable income
Taxable income is the portion of your income that’s used to determine how much you owe the federal, state, and local governments in taxes. It’s usually calculated by taking your total annual income and subtracting any adjustments, deductions, or exemptions for which you’re eligible. Most types of income are considered taxable — This includes everything from hourly wages to annual salaries, fringe benefits, bonuses, interest accrued on your savings, dividends, and any dividends on investments. While the term “taxable income” is used to refer to the entirety of your taxable earnings, it’s sometimes used to label individual chunks of income, too. For instance, a bonus might be one example of taxable income.
Calculating your taxable income can be pretty complicated, so it helps to break it down into steps. While the process varies slightly depending on the type of taxes you’re filing (federal or state), the main steps are pretty similar. Here’s a general example:
- First, you need to know your gross income. Let’s say you have a full-time job with an annual salary of $75,000. In your free time, you also like to collect and sell rare vinyl records. When tax season rolls around, you receive a W-2 from your employer showing your annual salary. That year you also made an $8,000 profit from your records sales. Between your salary and side hustle, you earned a gross income of $83,000.
- Once you know your gross income, you then subtract any qualifying adjustments. Adjustments are specific expenses in a given year — Like school tuition or certain retirement contributions — that the government says you can deduct from your gross income to lower your overall tax liability. So let’s say that in the same year you earned $83,000, you also paid $5,000 in tuition to take business classes at your local community college. The tuition is an example of an adjustment allowed by the government. If the tuition was your only adjustment that year, then you’d be left with an adjusted gross income (AGI) of $78,000.
- Next you determine which deductions you’re eligible for. Deductions are similar to adjustments in that they also lower your overall tax liability. You typically choose from one of two types: the standard deduction or itemized deductions. The standard deduction is a flat amount set by the Internal Revenue Service (IRS) each year. Each taxpayer’s standard deduction can vary depending on their tax filing status. If you’re a single taxpayer in 2021, the government allows you a standard deduction of $12,550 ($25,100, if married filing jointly). So, in this example, that would leave you with a taxable income of $65,450. That is $78,000 minus $12,550 = $65,450.
Note: Taxes for 2021 are due in spring 2022. Taxes for 2022 are expected to be due in spring 2023.
If the standard deduction is like the free spot on a bingo board, taxable income is like the rest of the board, which you have to fill in...
With the standard deduction, most taxpayers get a freebie of sorts. There’s a fixed amount—$12,550 for single filers in 2021—which almost any taxpayer can deduct from their annual income. What’s left, though, is subject to taxes. Just like you need to fill up the rest of your bingo board, you’ll pretty much have to pay taxes on the rest of your income.
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- What's the difference between gross income and taxable income?
- What are some examples of taxable income?
- How do adjustments and deductions affect my taxable income?
- Do my credits affect taxable income?
- How do I calculate my taxable income?
- What is the difference between taxable income and non-taxable income?
- What are some examples of non-taxable income?
What's the difference between gross income and taxable income?
Gross income and taxable income often go hand in hand, but there are important differences. Gross income is the sum of all income you earn in a given tax year, including hourly wages, annual salaries, fringe benefits, bonuses, and interest earned on investments. Taxable income is the amount of your gross income that remains after you account for adjustments, deductions, and/or exemptions. Your taxable income is used to help determine how much you owe the federal, state, and local governments.
What are some examples of taxable income?
Salaries and wages are two of the most common types of taxable income, but there are many more types of income that the IRS treats as taxable. Here are some examples:
- Jury duty pay
- Canceled debts
- Prizes and contest winnings
- Profits from a yard sale
- Unemployment benefits
If you receive any of the above, you may need to report them as part of your gross income on your tax forms.
How do adjustments and deductions affect my taxable income?
Adjustments and deductions are similar in that both may lower your overall tax liability. In other words, the larger the amount of adjustments and deductions taken out of your gross income, the lower your taxable income. Still, there are a few distinctions worth noting.
Adjustments are specific expenses in a given year that the government says you can deduct from your gross income to determine your adjustable gross income (AGI). Examples of adjustments may include school tuition and certain retirement contributions.
Deductions are another set of expenses that can be subtracted from your AGI to lower your tax liability. There are two ways to apply deductions - the standard deduction and itemized deductions - and each taxpayer must choose one approach.
Do my credits affect taxable income?
Tax credits affect how much you owe in taxes, but they don't directly affect your taxable income. Credits are typically removed from your tax bill after taxable income is calculated. Examples of tax credits include the earned income tax credit, dependent child tax credit, and adoption credit.
How do I calculate my taxable income?
The process of calculating your taxable income will vary slightly depending on the type of tax you are filing (usually federal or state) and the types of forms you need to fill out. Generally speaking, you’ll start by reporting all income, remove exempted income or adjustments, then apply any appropriate deductions. The amount left is your taxable income. (Our example above offers a more detailed breakdown.)
What is the difference between taxable income and non-taxable income?
Federal and state governments consider most types of income as taxable. Taxable income refers to the amount of income that’s used to determine how much you’ll pay in government taxes. It’s usually the amount of income left after subtracting any exceptions and deductible expenses. But there are certain types of income that are classified as "non-taxable", or income that isn’t subject to taxes. Non-taxable income is usually still reported on income tax forms, but it's exempt from being taxed.
A few types of non-taxable income, like US Veterans Administration disability benefits, do not need to be reported on tax forms in most cases. Taxable and non-taxable income designations and reporting rules may vary between federal (IRS) and state revenue departments.
What are some examples of non-taxable income?
According to the IRS, examples of non-taxable income include:
- Personal gifts
- Capital gains on the sale of your primary home (note: there is a cap)
- Your federal income tax refund from the previous year (some states do tax this, however)
- Debts canceled due to bankruptcy in some cases
- Foster care payments
- Life insurance payouts
- Disability benefits (provided you paid the premiums)
- Social Security benefits (provided you meet income limits)
Robinhood does not provide tax advice. Please consult with a tax professional regarding your personal circumstances.
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