What is Taxable Income?
Taxable income refers to any individual’s or business’ compensation that is used to determine tax liability. The total income amount or gross income is used as the basis to calculate how much the individual or organization owes the government for the specific tax period.
One important thing to remember about taxable income is that it includes not just one’s salary but also compensation in other forms, such as tips, bonuses, allowances, commissions, and winnings.
Types of Taxable Income
Every taxpayer knows that failure to file a report for one’s income tax can lead to serious consequences. So, to be sure about paying taxes, here’s a list of the types of income:
1. Employee compensation and benefits
These are the most common types of taxable income and include wages and salaries, as well as fringe benefits.
2. Investment and business income
For people who are self-employed, they are also subject to tax liability, specifically through their business’ income. For example, net rental income and partnership qualify as taxable income.
3. Miscellaneous taxable income
This includes income that doesn’t fit into the other types. It includes death benefits, life insurance, and canceled debts. Alimony, items involved in barter trading, and income from one’s hobby are also miscellaneous taxable income.
Taxable vs. Non-Taxable Income
Taxable income means all types of compensation, whether they are in the form of cash or services, as well as property. Unless a particular income is expressly exempted by law from tax liability, every income is taxable and should be reported in the income tax return. Examples include:
- Interest received from banks
- Stock options
- Unemployment compensation
- Notes received
- Rents from personal property
Non-taxable income, on the other hand, refers to income that is received but that is not subject to taxation. However, even if such forms of compensation cannot be taxed, they still need to be reflected in the tax return. Examples of non-taxable income are:
- Cash rebates from items bought
- Child support payments
- Welfare benefits
- Meals and lodging
How to Compute Taxable Income
Every tax season drives workers to calculate their income to determine how much tax they are supposed to pay. Though some people can do it by themselves, some seek the help of accountants. Below are simple steps to try to determine one’s adjusted gross income.
- Determine total income. Individuals should put together all compensation received.
- Compute unearned income. Unearned income refers to income that is obtained without having to work for compensation such as dividends, alimony, unemployment compensation, and real estate income.
- Choose filing status. There are four filing statuses: single, married filing jointly, married filing separately, and head of household.
- Reduce the income. Form 1040 contains a list of common deductions for taxable income.
- Compute for adjusted gross income. After summing up all the deductions in the previous step, the figure will further be deducted from the total income to come up with the “adjusted gross income.”
Thank you for reading CFI’s explanation of taxable income. CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: