What is Taxable Income?

Taxable income includes more than your usual wages and salary. Don't forget any other sources of income when using taxable income to file taxes.

Your income and your taxable income may not be the same. First, there are several different ways to calculate income, like gross income vs net income. Second, there are different ways to calculate how much of that income is taxable, like adjusted gross income and modified adjusted gross income. There are also many adjustments, tax credits, and deductions to consider that will change how much of your earnings are taxable. 

All of these numbers are things you'll need to know in order to properly file taxes. Understanding taxes, income calculations, and how they work together will also help you more accurately understand your tax bracket and your tax liability. 

What is Taxable Income?

Taxable income is the amount of a taxpayer's yearly earnings that are subject to tax. Sometimes you might also hear the term, income tax. This is a type of federal tax, or sometimes state tax, that is applied to your annual earnings. 

The reason the term taxable income exists is that your total income isn't necessarily the same as your taxable income. Things like tax exemptions, credits, deductions, or adjustments can make some part of your total annual income free from tax. 

This is why we file taxes each year and fill out 1040 forms with lots of financial information. This information will help the IRS determine how much of your income is taxable vs how much is tax deductible. Then, how much you owe in taxes will be determined from this number, rather than your total income. 

1040 document below an IRS check

How Does Taxable Income Work?

Taxable income is all forms of income minus tax deductions that apply to you. All of your income is subject to federal, state, and local taxes. By all types of income that means active and passive income.

Active income can also be more commonly referred to as earned income. It is the income that you are actively working to earn. For example, if you work in an office and receive a paycheck every 2 weeks, that income is considered active income, or earned income. 

Passive income can also be referred to as unearned income. It is more commonly referred to as passive income, however. It is the income that you receive, but there's no active work involved in gaining that income. For example, if you have a savings account with an interest rate of growth, then the income you receive from that percent of savings account growth is passive income.

Other forms of passive income include interest earned from a savings account, bonds, alimony checks, or investment dividends. It is important to know that passive income is also subject to tax, so when you are calculating taxable income, don't forget to add together all your forms of passive income as well. 

How to Calculate Taxable Income

Taxable income isn't just the money from a typical paycheck. It also includes all sources of income, including side gigs and freelancing. Any form of income you can think of is included in the number that you start with when calculating taxable income. You need to get your total earnings number together first before you can start figuring out how much of that money is subject to tax. 

Step 1: Add All Sources of Income Together

Make sure you don't forget anything when adding this number together too. It might be easy to think about your paycheck as being your source of income, but if you have any other means of earning money throughout the year, then you'll want to include those too. 

Sources of Income Examples:

  • Paycheck 
  • Freelance 
  • Small business 
  • Side gig 
  • Rental income 
  • Capital gains 
  • Royalties 
  • and more
coins stacks growing

Step 2: Add All Deductions Together 

Once you have all your sources of income added together, it's time to take a look at potential deductions and which ones apply to you. These tax deductions include forms of nontaxable income. After you've added together all the deductions you qualify for, you'll want to subtract these deductions from your total income. 

Tax Deduction Examples:

  • Health insurance premiums 
  • Charitable donations 
  • Childcare expenses 
  • Student loan interest payments 
  • Some business expenses 
  • and more

Step 3: Subtract Deductions from Income

Once you have your total income and total deductions, subtract your deductions from your income. The number you'll be left with is your taxable income. This is sometimes referred to as your adjusted gross income, because it is your gross income (aka, your total income) adjusted with the subtraction of relevant tax deductions. 

How to Reduce Taxable Income

How much you pay in taxes each year depends on many factors, but it all boils down to the IRS tax code. This tax code dictates things like how taxable income is calculated, what's included in taxable income, and the percentage rates used for each level of income. 

Basically, how much you pay in taxes increases as your income increases. The best way to reduce your taxable income is to take any and all tax deductions and credits you can. These will reduce your taxable income and help you pay less in taxes overall. Using a tax professional can help you go over all your available tax deductions, credits, and itemizations so you don't miss out on any tax savings.

Get Both Your Federal and State Taxes Filed at Check City!

There are tax breaks for homeowners that could apply to you if you own a home. There are child tax credits for if you have a child or qualifying dependent under your care at home. There are also many deductions you can itemize if you have qualifying business expenses, or if you have property tax expenses that the federal government lets you deduct. 

Is Social Security Taxable Combined Income Taxable?

Social security is a unique form of income. Social Security is a part of a government retirement plan. Taxes go toward this Social Security fund and then qualifying retiring individuals can receive Social Security benefits in their retirement. 

Retired individuals who receive Social Security benefits get a monthly payment just like they would receive a monthly or biweekly paycheck from their work. This Social Security income is treated just like earned income by the IRS and is taxed just like earned income. 

Sample Social Security Card

Is Per Diem Taxable?

What is per diem? A per diem is a type of allowance a company or organization might give an employee for certain expenses. For example, if your company gives you a company card to pay for gas, then that money is called per diem. 

Per diem is not considered an additional wage or income by the IRS. Therefore, per diems are not taxed. But, if this per diem, employee allowance doesn't meet the federal requirements for per diems, then this money is considered an extra wage and is subject to taxes. 

Per Diem Requirements

  • Per diem allowances are greater than the current federal per diem rate 
  • The per diem recipient did not file an expense report to the employer

Is Net Pay Taxable?

What is net pay and is it taxable income? Net income refers to your income after taxes have already been taken out. So net pay and taxable income aren't really the same thing. Net income is the income you have left over after taxes while taxable income is the income you have that is subject to being taxed. Net income is your take-home pay, the amount of money you get to take home in your paychecks after an employer has already deducted payroll taxes

In Conclusion,

Understanding your taxable income is important to understanding everything about your taxes. It can impact your tax status, your tax bracket, your tax percentage rate, and how much you end up spending in taxes overall. Work with a tax professional in order to get your maximum tax deductions so you can not only get your biggest tax refund, but reduce taxable income as well.