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This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma Tax®. It has been updated for the 2019 tax year.
Most Americans get their income from multiple sources, according to a Federal Reserve study.
These sources include traditional W-2 earnings, self-employment ventures, investment dividends, retirement income, unemployment and much more. With so many taxpayers receiving multiple types of income, it’s no surprise that calculating taxable income can get complicated.
Let’s look at the types of income the IRS defines as taxable, what income could be excluded from taxes, and some common questions you might have about taxable income.
- What is ‘taxable income’?
- What types of income must you pay taxes on?
- What types of income are not taxed?
- How does taxable income affect how much tax I owe?
- How does taxable income affect my refund?
- How can I reduce my taxable income (without losing money)?
- Some frequently asked questions about income
What is ‘taxable income’?
The IRS says income can be in the form of money, property or services you receive in the tax year. The two basic types of income are earned and unearned income.
Earned income includes money you receive from an employer in exchange for your work or money you make working for yourself. Unearned income includes money you didn’t directly work for, such as interest and dividends, Social Security payments, alimony, etc.
To arrive at your taxable income, you’ll first need to calculate your adjusted gross income, or AGI. Your AGI is basically all your taxable earned income less any income adjustments you’re eligible to take before you get into itemizing deductions.
On Form 1040, you report your total income in the section marked “Income,” including things like W-2 income, taxable interest and ordinary dividends. Schedule 1 allows you to report other types of income, such as alimony you received, unemployment income or business income. Schedule 1 also lists adjustments to income such as contributions to health savings accounts, contributions to a traditional IRA, interest paid on student loans, alimony you paid and more. For more information on how to calculate adjusted gross income, visit the IRS website for Form 1040.
What types of income must you pay taxes on?
The IRS counts the following common income sources as taxable income:
- Wages, salaries, tips and other taxable employee pay
- Union strike benefits
- Long-term disability benefits received prior to minimum retirement age
- Net self-employment or freelance earnings under certain circumstances
- Jury duty fees you earned
- Security deposits and rental property income
- Awards, prizes, gambling, lottery and contest winnings
- Back pay from labor discrimination lawsuits
- Unemployment benefits
- Capital gains (there’s an exception for the selling of a property that’s your primary residence)
- Severance pay from a previous job
- Alimony from an ex-spouse
- Interest or dividends from investments
- Royalties and license payments
- Canceled debts (but there are key exceptions for those declaring bankruptcy)
What types of income are not taxed?
You don’t have to pay taxes on all income, though. This category generally includes …
- Workers’ compensation benefits
- Child support payments
- Life insurance proceeds unless the policy was turned over to you for a price
- Disability benefits (if you contributed to the premiums from your salary)
- Social Security benefits (depending on your filing status and other income)
- Capital gains on the sale of your primary home (up to certain thresholds)
- Money received as a gift or other inherited assets (the exception here is, if you’ve earned money as a result of that gift, you owe taxes on those earnings)
- Canceled debts intended as a gift to you
- Scholarships or fellowship grants
- Foster care payments
- Federal income tax refund
- Money rolled over from one retirement account to another via trustee-to-trustee transfer
For full instructions on what constitutes taxable and non-taxable income, see IRS Publication 525.
How does taxable income affect how much tax I owe?
Your taxable income determines your tax bracket, which in turn influences your income tax rate and the amount of tax you owe. Federal income tax is progressive, which means that income tax rates increase as a person earns more income.
Lower taxable income can mean you’re in a lower tax bracket with a corresponding tax rate — and your tax liability will likely be lower.
How does taxable income affect my refund?
You probably noticed that a portion of your paycheck goes toward federal taxes. Or, if you’re self-employed, then you’ve (hopefully) been paying quarterly taxes throughout the year.
If you paid more federal income tax than you owed based on your taxable income, you may receive a refund. The more tax you overpaid, the bigger your refund.
How can I reduce my taxable income (without losing money)?
You can lower your taxable income — and possibly increase any tax refund you’re owed — in two basic ways.
First, you can lower your AGI by subtracting as many adjustments as you’re legally entitled to. Second, tally up all your allowable credits, deductions and exemptions to determine whether you’ll save more by itemizing deductions or taking the standard deduction. Generally, you want to use whichever option saves you more.
Take note here: Some adjustments (often referred to as “above-the-line-deductions”) may lower your overall AGI, but also will limit the deductions or credits you can take for “below-the-line” deductions. For example, if you had a lot of deductible medical expenses during the tax year, then you’re only allowed to deduct the amount of your total medical expenses that exceed a certain percentage of your AGI on your itemized Schedule A.Learn more about the medical expense deduction
Here are some strategies for lowering your taxable income.
- Max out your retirement contributions — Contributions to 401(k)s and traditional IRAs may be tax deductible. You generally don’t pay taxes on the income you’re allowed to contribute to these retirement plans, and you don’t get taxed on their earnings. But you’ll pay taxes later when you take money out of these accounts.
- Charitable donations — You may deduct charitable contributions made to, or for the use of, a cause or charity as long as that organization is a registered charity under Section 501 (c)(3).
- Defer your year-end bonus — If you’re expecting a holiday bonus, ask your employer to give it to you in the next year so you don’t owe additional taxes on that income.
- Tidy up your investment accounts — If investments in your portfolio have lost money and you sell them, you could claim those losses and offset any capital gains you report.
Some frequently asked questions about income
In some situations, Social Security income may be subject to federal income tax. You may have to pay taxes on Social Security benefits if …
- Your federal income tax filing status is single and your combined income (AGI plus non-taxable interest) between $25,000 and $34,000 in the tax year. Or, you file jointly and have combined income of $32,000 to $44,000. In these cases, you could have to pay income tax on up to half of your benefits.
- You file as an individual and earn more than $34,000 in combined income, or you filed jointly and have combined income of more than $44,000. You could have to pay income tax on up to 85% of your Social Security benefits.
They could be. You could have to pay income tax on disability benefits if your employer paid a portion of the disability insurance policy premium.
If you and your employer share the cost of the premiums, you’ll need to report the amount of disability income that you get based on your employer’s payments. That portion could be subject to income tax.
Yes, the IRS considers income from unemployment benefits taxable in most cases. Typically you can elect to have federal income tax automatically deducted from your unemployment payments at the time you enroll.
You generally don’t have to pay income taxes on inherited money. That money is taxed before you receive it from the person or estate bequeathing the money. But if you invest it or create earnings using that money, you’ll have to pay tax on those earnings.
Also keep in mind that the deceased person’s estate may have to pay the federal estate tax if the amount of the estate exceeds a certain threshold. For 2019, that threshold is $11.4 million. Note that some states have estate or inheritance taxes (or both) that may also apply.
I received a monetary gift. Is that taxable income?
Similar to the above answer, a monetary gift from a friend or family member is typically non-taxable.
Yes, gambling winnings do count toward your taxable income, and you must report them on your Form 1040.
My company pays a bonus, tuition reimbursement and some other awesome benefits. Are those taxable income?
The IRS considers bonuses and fringe benefits such as use of a business vehicle to be taxable income. As long as the tuition reimbursement meets the criteria for the Education Working Condition Fringe Benefit Exclusion, the tuition reimbursement is not taxed until it exceeds $5,250.
Having multiple types of income can mean more money, which most people would consider a good thing. But more tax complexity can accompany having more sources of income.
You can take charge of your taxes by understanding what the IRS considers taxable income, what it doesn’t count as taxable, and how taxable income gets calculated.
Credit Karma Tax®, a free online tax preparation service, can help you complete your federal and state tax returns using multiple types of income. The service uses a series of questions about your finances and lifestyle to help identify tax deductions and credits you could be eligible for.
Relevant sources: Report on the Economic Well-being of U.S. Households in 2016, Board of Governors, Federal Reserve System | IRS Publication 525: Taxable and Nontaxable Income | IRS: What is Earned Income? | IRS: About Form 1040-EZ, Income Tax Return for Single and Joint Filers with No Dependents | IRS Form 1040 | IRS Publication 527: Residential Rental Property | IRS Topic No. 431: Canceled Debt – Is it Taxable or Not? | IRS Publication 523: Selling Your Home | IRS 1040 Instructions | IRS Publication 4491: VITA/TCE Training Guide | IRS: 401(k) Plans | IRS: Retirement Topics – IRA Contribution Limits | Social Security Administration: Benefits Planner – Income Taxes and Your Social Security Benefit | IRS: FAQ – Life Insurance & Disability Insurance Proceeds | IRS: Estate Tax | IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits
Christina Taylor is senior manager of tax operations for Credit Karma Tax®. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.