A Comprehensive Guide to Taxable and Non-Taxable Income
In this reference article, we will explain the difference between non-taxable income and taxable income. This is critical information to know since not paying your fair share of taxes can have serious consequences. Distinguishing what income is taxable and non-taxable is a necessary step that impacts your tax liability.
What is income?
Income is received in money, property or services. Income can be received on a one-time basis (gifts) or in regular payments (salary or wages).
What is taxable income?
Taxable income is income that a person or business receives that determines how much taxes you pay to the IRS. The gross income amount is what is reported on your tax return and used to calculate your tax liability at the end of the year. After your gross income is reduced by adjustments and deductions, the result is your taxable income. Simply put, taxable income is subject to tax. The amount of your taxable income also determines your tax rate - but we will discuss that later in this article!
What is non-taxable income?
Non-taxable income is income that is not subject to tax by the government. Most common tax-free income are gifts and government need-based benefits. You are not required to report non-taxable income on your tax return. If you choose to report it, it will not affect your tax liability or tax refund.
Keep reading below as we have made it easy and simple in this article to understand which income is taxable and which is tax free!
Common Types of Taxable Income
Taxable income is simply income that you receive from anywhere (even illegal income may be taxable). Income is generally taxed by the government unless it is explicitly made exempt. You will pay both Federal and state taxes on any taxable income received. Unless the state you reside in does not have state taxes. Most common taxable incomes are wages and salaries. Wages and salaries from a W-2 must be reported on your tax return because they are taxable. Other types of taxable income, for example, are unemployment income, social security, gains from sale of stocks, interests, dividends, pensions, retirement plans such as IRAs and 401(k), bartering services, gifts, prizes, rental income, royalties, court award payments, and gambling.
Employee compensation and benefits:
Wages, salaries, tips, and fringe benefits are some types of employee compensation. Your employer will pay you a salary and wages regularly. This income will usually have Federal and State taxes withheld from each paycheck that you receive. You can adjust your deductions based on your personal situation on your W-4 form at any time with your employer. The amount of deductions impacts how much taxes are taken out of each paycheck. If you have too little taxes withheld, you will owe the IRS when you file your tax return. If too much tax was withheld from your paycheck, you will qualify for a tax refund. To report your wages on your tax return, you will need the information from your W-2 you receive at the end of the year. If there are any mistakes in the W2 form you have received, please let your employer know immediately.
Fringe benefits provided to you by your employer are taxable income. These benefits are treated in the same way as employee compensation. Even if your spouse or someone else receives them on your behalf, you must still pay taxes on those benefits. Here is a list of common fringe benefits below:
- Company vehicle made available for personal use
- Tuition fees paid by company over certain threshold
- Holidays gifts from your employer including cash and gift cards
- Off-site gym membership provided by employer
- Dependent care paid by employer
- Life insurance paid by employer over a certain threshold
- Financial counseling services paid by employer
When you think of income, you think of cash, direct deposit or a cashed check, right? But what about that check you forgot to deposit in your bank at the end of the year? Yes, that income is taxable. Why? Simply because the check is still considered income - even if it is lost under a pile of papers on your desk! You must report uncashed checks on your tax return even if you did not deposit it.
While it is beneficial to make investments for long-term financial success, it can be costly during tax time. Investment incomes such as stocks sales, interests and dividends must be reported on your tax return, as you will owe taxes on this income. With digital currency and crypto currency becoming more prevalent in the investment world, it is more important than ever before to understand the taxes you will need to pay. Just small savings on your tax bill can have an impact on how quickly you accumulate your wealth over time. Therefore, keeping tax costs in mind when it comes to financial planning is important when it comes to things like tax smart investments.
Self- Employment, Freelance or Business Income:
Any type of income you have received from your business is taxable. Self-employment income, freelance income or income received from property rentals are subject to taxes. Federal and state taxes are not withheld throughout the year from self-employment income or other business income. Instead, you will need to submit quarterly estimated tax payments or pay taxes when you file your tax return. If you are self-employed or have your own business, it is important to keep track of your business expenses to lessen your tax bill. Many business expenses are tax-deductible and will reduce what you owe at tax filing time. Expenses such as gas for your vehicle, office supplies, and utilities directly related to your business and work are all deductible.
It can be confusing to know which income is taxable and which is not. But the IRS has strict rules that require you to report all taxable income on your tax return. Here are common types of taxable income that are not so easy to distinguish:
- Employer contributions to an unqualified retirement plan
- Bartering for services or property
- Employer-paid disability retirement plans
- Employer-paid sickness and injury payments
- Fair-market value of property you received in exchange for services
- A remaining portion of debt that is forgiven or cancelled
- Income received from offshore accounts
Traditional IRA Withdrawals:
Withdrawals from a traditional IRA account are taxable income and must be reported on your tax return.
Don’t forget that an IRA account is for your retirement savings. If you decide to dip in early, you will be penalized 10%. Please note, there are some exceptions to the penalty rule for early IRA withdrawals (such as with rollover Roth IRA accounts).
Here is a complete list of taxable incomes
- Fringe Benefits
- Cash Income
- Self-Employment Income
- Freelance Income (side hustle)
- Investment and Business Income (property rentals)
- Unemployment Benefits
- Digital Currency
- Cash Rebates (for items bought from retailer or dealer)
- Unearned Income (capital gains on investment)
- Strike Pay
- Child Support Payments
- Welfare Payments
- Alimony Payments (for separation agreements finalized before 1/1/2019)
- Qualifying Adoptions Reimbursement
- Healthcare Reimbursement/Healthcare Benefits
- Interest on Savings
- Stocks, Interests and Dividends
- Partnership Income
- S Corporation Income
- Barter Income
- Combat Pay to Service Members
- Contest Prizes
- Jury Duty Pay
- Monetary Awards
- Traditional IRA Withdrawals
Common Types of Non-Taxable Income
Non-taxable income is not subject to tax by the federal government. That means it is a tax-free income. Tax-free income is not required to be reported on your tax return because it is not subject to any taxes. Non-taxable income includes gifts, any child support payments received, worker’s compensation, welfare benefits, most inheritances, life insurance benefits received, withdrawals from a Roth IRA, healthcare benefits, disability insurance, garage sale income, qualifying scholarships income, court judgments received for injury or sickness, and home proceeds.
Child support payments you receive are tax free income as well. However, if your ex-spouse provides financial assistance for your child, it is not taxable income.
If you have received a gift from your family or friends, you are not taxed for it. However, the giver of the gift may have to pay a gift tax on their tax return.
Generally, inheritances are considered tax-free income. However, there are some exceptions. For example, some states in the United States have specific estate taxes. Other states impose inheritance taxes based on the benefit transfer and this differs across states. There is a federal estate tax for some estates with total assets of more than $12 million.
- States with inheritance tax are:
- New Jersey
- States with estate tax are:
- New York
- Washington, D.C.
- Rhode Island
Welfare and SNAP Benefits:
If you receive assistance such as need based welfare, it is tax-free. Non-taxable income includes both welfare and SNAP benefits. SNAP benefits are considered tax-free because they are based on need. This means receiving these benefits will not increase your tax liability when you file your tax return.
Supplemental Security Income (SSI):
Like welfare, SSI benefits are tax-free income because they are given on a need basis. If you choose to report it on your return, it will not increase your tax liability.
Foster Care Payments:
Foster parents caring for foster children may receive assistance from the government to cover their financial burdens. Foster care payments are non-taxable.
Life Insurance Proceeds:
Life insurance benefits are non-taxable although the interest earned may be taxed.
Interest on municipal bonds:
Municipal bonds are the only types of federal government bonds that are non-taxable for purposes of your federal income tax return. Interest from federal savings bonds is taxable on your federal income tax return, but not your state or local income tax returns.
Roth IRA Withdrawals:
Unlike a traditional IRA account, 401(k) or 403(b) plan – you are not taxed for withdrawing qualified income from a Roth IRA account. Your contributions consist of post-tax money which is tax-free when withdrawn. Non-taxable income also includes Roth 401(k) and Roth 403(b) withdrawals.
Here is a complete list of non-taxable incomes:
- Welfare and SNAP benefits
- Worker’s Compensation
- Child Support Payments
- Foster care payments
- Adoption Assistance from Employer
- Garage Sale Proceeds
- Health Insurance Benefits
- Life Insurance Proceeds
- Interest on Municipal Bonds
- Black Lung Disease Benefits
- Supplemental Security Income – SSI
- Combat Pay
- Gambling Income
- Interest on Municipal Bonds
- Vacation Rental Income (Limited)
- Disaster Relief Grants
- Casualty Insurance
- Payments From State Crime Victims’ Fund
- Compensatory Damages for Physical Illness or Injury
- Roth IRA Withdrawals
In addition to this list, some incomes are only non-taxable if they fall under certain conditions. ezTaxReturn offers FREE customer support for any questions you may have when filing your tax return. Here are some exceptions to non-taxable income:
- If you have used money from a qualified scholarship specifically for room and board and to pay for personal items, then a portion is taxable.
- Even though life insurance benefits received when someone dies is not taxable, if a life insurance policy is cashed, then at least a portion of it is taxable.
Determining Your Tax Liability
While taxable income is a key factor that determines what you owe to the IRS, there are other factors that determine your tax liability. For example, the tax rate that applies to your taxable income is used to calculate how much you owe. Income tax rates and tax brackets are dependent on the amount of taxable income you receive. Tax rates are the rates at which someone is taxed based on their taxable income.
There are currently seven different income tax rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The more taxable income you have, the higher your tax rate, and the more taxes you pay. Generally, higher income means paying more taxes. Tax brackets are “ranges” or “brackets” of income that are taxed at different rates. They are annually adjusted for inflation and determine the tax rate you qualify for.
We have included the tax rates for 2022 below.
2022 Single Filer Tax Bracket
|Tax rate||Taxable income||Tax owed|
|10%||$1 to $10,275||10% of taxable income|
|12%||$10,276 to $41,775||$1,028 + 12% of the amount over $10,275|
|22%||$41,776 to $89,075||$4,808 + 22% of the amount over $41,775|
|24%||$89,076 to $170,050||$15,214 + 24% of the amount over $89,075|
|32%||$170,051 to $215,950||$34,648 + 32% of the amount over $170,050|
|35%||$215,951 to $539,900||$49,336 + 35% of the amount over $215,950|
|37%||Over $539,900||$162,718 + 37% of the amount over $539,900|
2022 Married Filing Jointly Tax Bracket
|Tax rate||Taxable income||Tax owed|
|10%||$1 to $20,550||10% of taxable income|
|12%||$20,551 to $83,550||$2,055 + 12% of the amount over $20,550|
|22%||$83,551 to $178,150||$9,615 + 22% of the amount over $83,550|
|24%||$178,151 to $340,100||$30,427 + 24% of the amount over $178,150|
|32%||$340,101 to $431,900||$69,295 + 32% of the amount over $340,100|
|35%||$431,901 to $647,850||$98,671 + 35% of the amount over $431,900|
|37%||Over $647,850||$174,254 + 37% of the amount over $647,850|
It is important to understand tax rates and tax policies such as the Inflation Reduction Act. This tax law was implemented to offset the effects of inflation. Inflation causes people to move into a higher tax bracket which is called “bracket creep”. For the Americans that do not have higher incomes, this means owing more taxes without a higher salary. Bracket creep also affects deductions, credits and exemptions making them less valuable. Deductions are meant to reduce what Americans owe in taxes by decreasing tax incomes.
To avoid bracket creep, the IRS makes changes every year to its tax policy to counteract the effects of inflation. When we are seeing high inflation, the adjustments to deductions and credits will be more useful to tax-filers looking to save money. Without bracket adjustments every year, a bracket creep would move many Americans into a higher tax bracket without an increase in income.
How to Reduce Taxable Income
With a lower taxable income, you pay less income taxes. There are several ways to reduce your taxable income. One of the best ways is to invest in your retirement. Making contributions to a traditional IRA account or your employer’s 401k plan will reduce your taxable income because the money is taken out of your earnings before it gets taxed. Alternatively, you can contribute to a health savings account (HSA). HSA contributions reduce your taxable income, your earnings grow tax-free, and your withdrawals are tax-free when used to cover qualified medical expenses.
You can also take advantage of valuable tax deductions. A tax deduction can decrease your taxable income when filing taxes. There are two types of deductions you can claim on a tax return – itemized deductions or the standard deduction. The standard deduction is a set standard amount based on your age and filing status. The standard deduction amount changes each year. An itemized deduction is a custom approach to deducting your expenses, it is not a “one size fits all” set amount. You can take an itemized deduction if your expenses exceed the standard deduction limits. Deductible expenses include out-of-pocket medical and dental costs, mortgage interest and charitable donations. Make sure to keep your receipts for your expenses when it comes to claiming these deductions at tax filing time.
With the information described above on taxable income, non-taxable income, and tax rates - you can accurately calculate the amount of taxes you owe. Things like tax deductions have an impact on how to reduce your taxable income. Getting your taxes done is not a race, it is a marathon. It takes boundless knowledge of financial literacy as the Federal and State tax laws change on a consistent basis. By understanding which income is taxable and non-taxable, you can make smart financial decisions to lessen your tax liability. We ask all the right questions to help you optimize your tax liability.
When tax filers do not report all their taxable income, their tax liability decreases. Paying less in taxes than what you truly owe is called tax evasion, which is a crime. If you do not report all your taxable income on your tax return, you can face criminal and civil penalties. The IRS requires all sources of taxable income to be reported and the liability paid before the tax filing deadline. We hope our information here has been helpful to you for reporting all the necessary income on your tax return.