You and your business pay tax based on taxable income, which does not include all income. Understanding taxable income allows for more effective tax planning.
What is taxable income?
Taxable income is the amount used to calculate federal income tax liability before tax credits and payments.
The term “taxable income" often gets confused with income subject to tax. Income subject to tax refers to individual income items—such as wages—that count as income on your tax return. Add all income subject to tax to determine total income. Taxable income equals total income minus deductions.
Non-taxable income—also referred to as exclusions from income or tax-exempt income—includes any income not subject to tax. The IRS does not consider non-taxable income as income at all, though it requires disclosure of some non-taxable income on the tax return for informational purposes.
Unlike deductions—specific expenses or allowances permitted to reduce taxable income—non-taxable income never affects the taxable income calculation. Despite its name, the term “total income" on a tax return does not include non-taxable income.
What is an example of taxable income?
Income subject to tax includes all income not specifically defined as non-taxable income. Which income items qualify as non-taxable varies between individuals, C corporations, estates, and trusts. Consult your tax professional if you aren't sure whether a particular income source qualifies as non-taxable.
For individuals, five common types of income subject to tax include:
Non-taxable income sources for individual federal income tax include:
- Interest from municipal bonds
- Gifts—although the donor may owe gift tax
- Inheritances—although the estate may owe estate tax
- Most Roth retirement account distributions
- Most health savings account distributions
For an example of how to calculate an individual's taxable income, say Jane has $40,000 of wage income from her job, $25,000 of Schedule C business profit from her side business, $2,000 interest from municipal bonds, and a 2021 standard deduction of $12,550. She does not qualify for any other deductions.
Her total income on her individual federal income tax return equals $65,000—that's $40,000 of wage income plus $25,000 of business income. She must disclose $2,000 of municipal interest, but it doesn't count towards her total income because it's non-taxable income. With $65,000 of total income minus her standard deduction of $12,550, Jane has taxable income of $52,450.
How to find taxable income
The concept of taxable income applies to individuals, C corporations, estates, and trusts. Pass-through entities including S corporations and partnerships do not have taxable income on their returns, because most income and deductions flow to their owners' tax returns.
Individuals can find taxable income on line 15 of Form 1040. Line 30 of Form 1120 shows a C corporation's taxable income. Form 1041 reports taxable income for estates and trusts on line 23.
Individuals, C corporations, estates, and trusts all follow very different tax rules. Income subject to tax, nontaxable income, and allowable deductions vary significantly between individuals and the different entity types. However, the basic concept behind taxable income remains consistent. Total income—all income subject to tax—minus deductions equals taxable income.
Taxable income allows individuals and relevant entities to calculate federal income tax liability, subject to certain adjustments. The exact formula differs between individuals, C corporations, estates, and trusts.
Understanding the difference between taxable income and non-taxable income can help you or your business plan for taxes. Opting for non-taxable income over income subject to tax will reduce taxable income and thus tax liability. Knowing how to calculate taxable income also allows you or your business to pay the correct amount of tax.
Find out more about Business Taxes
FAQs
Most income is taxable unless it's specifically exempted by law. Income can be money, property, goods or services. Even if you don't receive a form reporting income, you should report it on your tax return. Income is taxable when you receive it, even if you don't cash it or use it right away.
How do you explain taxable income? ›
Generally, an amount included in your income is taxable unless it is specifically exempted by law. Income that is taxable must be reported on your return and is subject to tax. Income that is nontaxable may have to be shown on your tax return but is not taxable.
How do I figure out my taxable income? ›
For individual filers, calculating federal taxable income starts by taking all income minus “above the line” deductions and exemptions, like certain retirement plan contributions, higher education expenses, student loan interest, and alimony payments, among others.
What amount counts as taxable income? ›
Income received as wages, salaries, commissions, rental income, royalty payments, stock options, dividends and interest, and self-employment income are taxable. Unemployment compensation generally is taxable.
How does taxed income work? ›
You pay tax as a percentage of your income in layers called tax brackets. As your income goes up, the tax rate on the next layer of income is higher. When your income jumps to a higher tax bracket, you don't pay the higher rate on your entire income.
How much federal tax do I pay on $80,000? ›
If you make $80,000 a year living in the region of California, USA, you will be taxed $21,763. That means that your net pay will be $58,237 per year, or $4,853 per month.
What is income tax for dummies? ›
Income tax is a type of tax governments impose on income generated by businesses and individuals within their jurisdiction. Income tax is used to fund public services, pay government obligations, and provide goods for citizens.
What is not considered taxable income? ›
Disability and worker's compensation payments are generally nontaxable. Supplemental Security Income payments are also tax-exempt.
Is taxable income the same as net income? ›
Taxable income is your AGI minus your Standard Deduction (or itemized deductions from Schedule A) and your qualified business income deduction from Form 8995 or Form 8995-A. Net income typically means the amount of income left over after you pay your income tax or get a tax refund.
How is taxable income calculated per paycheck? ›
Federal Withholding Taxable Wages are calculated by adding all earnings (including any taxable fringe benefits) less all pre-tax deductions, and less any applicable 1042-S Wages. The tax rate(s) used in the calculation are specific to earnings being paid.
Gross income is all income from all sources that isn't specifically tax-exempt under the Internal Revenue Code. Taxable income starts with gross income, and then certain allowable deductions are subtracted to arrive at the amount of income you're actually taxed on.
How much can I deduct from my taxable income? ›
Standard deduction 2024
The standard deduction amounts for 2024 have increased to $14,600 for single filers, $29,200 for joint filers and $21,900 for heads of household. People 65 or older may be eligible for a higher amount.
Is social security considered taxable income? ›
About 40% of people who get Social Security must pay federal income taxes on their benefits. This usually happens if you have other substantial income in addition to your benefits.
How do I calculate my taxable income? ›
Learning how to calculate your taxable income involves knowing what items to include and what to exclude. Simply stated, it's three steps. You'll need to know your filing status, add up all of your sources of income and then subtract any deductions to find your taxable income amount.
What is defined as taxable income? ›
Taxable income is a term you've likely heard during tax season. Like it suggests, taxable income is the amount of a person's or company's income—minus exemptions and deductions—that can be taxed. Among the types of taxable income are a person's salary or wages, tips, benefits and investment income.
How much money do you have to make not to pay taxes? ›
About filing your tax return
If you have income below the standard deduction threshold for 2023, which is $13,850 for single filers and $27,700 for those married filing jointly, you may not be required to file a return.
What best describes taxable income? ›
Except as provided in subsection (b), for purposes of this subtitle, the term “taxable income” means gross income minus the deductions allowed by this chapter (other than the standard deduction).
What is the difference between taxable income and income tax? ›
Taxable income: This is the income on which tax is to be calculated and paid. This is your taxable income. Income tax: This is your tax liability which you are going to pay. This liability is calculated considering your total income, deductions, rebate etc.
