Knowing your taxable income (the amount of your income subject to federal tax that you must report on your federal tax return) is important for several reasons. The IRS requires that you report all taxable income and file an accurate tax return. Also, understanding taxable income can help you figure out how much tax you will owe, if any, and might help lower your tax bill.
The most common taxable income for many people is earned income (e.g., from wages, tips, bonuses, etc.).
However, some people are surprised that income from unemployment, Social Security, and other retirement benefits can also be taxable.
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Here’s more of what you need to know.
What is taxable income?
Taxable income is the part of your gross income (the total income you receive) that is subject to federal tax. Taxable income and gross income differ for several reasons.
- First, not all income is taxable.
- Additionally, tax deductions and credits can lower the amount of your income that is subject to tax.
- So, your federal taxable income is essentially your federal adjusted gross income (AGI) minus any tax deductions you claim. (More on that below.)
As mentioned, taxable income can include earned income (i.e., money received as pay for work performed) and unearned income (e.g., taxable interest, capital gains, dividends, etc.). Here are other examples of income that is taxable at the federal level.
- Commissions and bonuses
- Royalties
- Business income
- Interest and dividend income
- Canceled debts (with some exceptions)
- Lottery winnings
Note: Federal taxable income isn't always the same as state taxable income. That’s largely because not all states tax the above types of income, and some states don’t have income tax.
How to calculate taxable income
Determining federal taxable income involves taking all sources of income received during the year and subtracting certain "above the line" deductions. (Above-the-line deductions are adjustments from gross income. And you don't have to itemize to claim them.) The "line" in above-the-line refers to Line 11 on Form 1040, where AGI is listed.
Some above-the-line deductions include the following.
- Contributions to certain retirement plans, such as 401(k)s and IRAs, and SEP and SIMPLE plans
- Student loan interest paid
- Certain business expenses
- Penalties on certain early savings or CD withdrawals
- Contributions made to a health savings account (HSA)
- Deductible self-employment taxes
- Self-employment costs for health insurance premiums
- Educator expenses
- Alimony paid (divorced before 2019)
- Active duty military moving expenses (unreimbursed)
Once above-the-line deductions are subtracted from your income, consider your filing status and determine whether to claim the standard deduction or itemize deductions.
Learn more: What's the Standard Deduction?
Once you determine your taxable income (AGI minus all applicable deductions), that and your filing status determine your federal income tax bracket and marginal tax rate.
Note: Luckily, your tax preparer, if you use one, will calculate your AGI and taxable income for you. If you use a tax preparation product or do your taxes online, the software performs the calculations.
What is nontaxable income? Remember that not all income is taxed at the federal level. For example, life insurance proceeds you receive as a beneficiary and employer-provided health insurance are not included in gross income.
Gifts aren’t taxable as long as you don’t exceed the federal gift tax exclusion for 2023, which is $17,000 ($34,000 per married couple).
*These are just a couple of examples. Other types of income are not subject to tax.
Ways to lower your taxable income
The best way to lower your taxable income is to take advantage of all the tax deductions and credits you qualify for. Common but often overlooked tax deductions include charitable contributions and donations, student loan interest paid, and in some cases, unreimbursed medical expenses.
However, not everyone is eligible for every tax deduction or tax credit. A trusted tax professional can help ensure you don’t miss out on tax breaks you qualify for. A professional may also be able to formulate a tax strategy that aligns with your financial goals.
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