What Is Taxable Income?

As you know, U.S. citizens are subject to taxes based on their annual income. There are, however, distinct definitions of what “income” is under federal law. While most income is taxable (unless specifically exempted by law), and there is such a thing as nontaxable income, First, let’s take a moment to define income.

Legally, income is defined as money, goods, or other economic benefits received.  Income can be considered “active” when acquired through labor (either employed by someone else or being self-employed), or “passive” when acquired through avenues such as rentals, stock dividends, or any other investment that does not represent active labor nor management.

Now, what is taxable income? Well, taxable income is the amount of your gross income that is subject to tax after adjusting for deductions and exemptions. Your filing status —whether you are single, married, or filing as a head of household—also makes a difference when calculating your taxable income, as you will see further down in this article. Or, you could itemize your deductions from a big list of expenses, which include retirement plan contributions, student loan interest, alimony payments.

Let’s go over the different types of income, whether they are taxable and nontaxable, and how deductions play into your taxable income.

What Is Taxable Income?

Your taxable income is simply the portion of your total income that the IRS considers subject to taxes during a given year; another way of calling it is Adjusted Gross Income (AGI). According to the IRS, you can receive income in the form of money, property, or services. It’s important to add that your taxable income is generally less than your AGI because deductions will reduce it, whether you choose standard or itemized deductions.

Here are the types of taxable income according to the IRS:

• Employment Income: All wages and benefits acquired from being employed fall into this category. They are the most common type of taxable income and includes salaries and wages, tips, bonuses, and fees received from your employer.
• Self-Employment and Side Jobs Income: Any income from freelance or independent contractor work, including the sale of goods and services online, gigs or side jobs through online apps, rental property, royalties, and even value gained from bartering is considered taxable income.
• Business Income: Business owners are subject to tax liability, including the income from partnerships and other business entities. It’s important to note that business income is calculated by subtracting business expenses from their total revenue, then further subtract deductions; the resulting total is their taxable income. Also worth noting is the fact that the IRS does not tax partnership entities directly; instead, all income, deductions and losses are passed to all individual partners to declare on their own annual tax return.
• Investment Income: These include capital gains; income acquired through stock options, splits or trades; interest; dividends; and more recently, the value of digital assets and cryptocurrency.
• Non-business Benefits: This is a broad category that contemplates all sorts of benefits No acquired directly from employment, such as unemployment benefits, Social Security income, some life insurance and survivor benefits, and retirement plan distributions, pensions, or annuities.
• Miscellaneous Income: Anything not included in the categories above that is still considered taxable by the IRS, such as tax refunds, reimbursements and rebates; canceled debts; alimony payments; court awards and damages; gambling winnings, prizes and awards.

 

Deductions And Exemptions To Taxable Income

Standard vs. Itemized Deductions

The standard deduction is a set amount of money you can subtract out of your total income based on your filing status. Married individuals can also file separately, but the amount deduced is always lower than for couples filing jointly. This is the easier deduction to claim since it requires holding virtually no extra documentation or records of your expenses other than what you normally use in each tax season.

The following are the standard deductions for 2025:

• Single taxpayers and married couples filing separately: $15,000
• Married couples filing jointly: $30,000
• Heads of household: $22,500

Itemized deductions are considered below-the-line deductions, and include home mortgage interests, medical and dental expenses paid out of pocket, long-term healthcare premiums, charitable donations, losses incurred from casualty or theft, and many more.

As you can imagine, the standard deduction is the most popular option because it implies less work, as nearly 90% of taxpayers claim itemized deductions yearly. In order to itemize, you need to keep pristine records through the whole tax year on your deductible expenses, along with any supporting documents of those transactions. Still, if you believe that your itemized deductions outweigh your standard deductions (if, for example, you have a mortgage on your house), they could be of great help to you since your taxable income would be reduced significantly.

What Is Nontaxable Income?

As we have said, most types of income are considered taxable by the IRS in some form or another. Still, there are types of revenue that fall into the “nontaxable income” category (although most of them have exceptions).

The following types of income are considered nontaxable income:

• Financial gifts: Perhaps the most well-known category of nontaxable income, financial gifts are a form of nontaxable income up to the annual federal tax limit (which will be $19,000 for 2025.) Mind you, that is not $19,000 total, but up to that amount to as many people as you want; for married couples, that amount can be given to each spouse, essentially doubling the limit.
• Inheritances: There is no federal tax on inheritances, including cash, property, and others; however, there are a few caveats that you should keep in mind. Number one, while inheritances are not considered taxable income by the IRS, they might be subjected to state taxes. Number two, if the money or asset that you inherited generates income (such as interest-bearing accounts or a rental property), those earnings are taxable income.
• Disability benefits: Workers comp and disability payments are considered nontaxable, as are Supplemental Security Income and Department of Veterans Affairs payments (the latter exemption applies only to U.S. military Veterans.)
• Income from Roth Accounts: Distributions from a Roth account are tax exempt as long as the account is five years old since your first contribution and when you are 59 1⁄2 years old.
• Alimony and child support payments: All payments that you get from alimony or child support as part of a divorce agreement made after Jan 1, 2019 are nontaxable. In contrast, the person paying alimony cannot deduct those payments from their income tax (child support payments are nontaxable.)
• Long-term care insurance income: If you receive benefits from a long-term care insurance policy, those payments are not deemed taxable by the IRS.

There are other miscellaneous sources of income that are nontaxable under federal law, but the fact that some of those (and a few of the ones mentioned above) are considered differently under state tax law should be taken into account when filing your state taxes.

How To Calculate Taxable Income Step-By-Step

The following quick guide will take you through the basic steps of calculating your taxable income for an individual tax return.

Step 1: Choose Your Filing Status

Determining your filing status should always come first since you will carry that through the whole tax calculation process. If you are single, it comes without saying that you should file as a single taxpayer. It is usually recommended that married couples file their taxes jointly to take advantage of the higher deductions afforded by the IRS; if you do, you have to add both of your incomes together to determine the total, and also combine your deductions.

Still, there are a few reasons why spouses might decide to file their taxes separately. If that’s the case, you each have to add up your total income separately, divide up your deductions, and pay taxes separately as well. The same expenses cannot be used by both parties to calculate your separate deductions. Some other rules apply to married couples depending on the state, so be sure to check your state tax laws.

Step 2: Document All Your Sources Of Income

Depending on how you are filing your taxes, now you need to collect all the necessary documents to show all your sources of income. The most common forms to report income are the W-2 for employees, 1099-NEC for contractors, 1099-INT for interest you’ve earned, 1099-B for capital gains, and 1099-DIV for dividends; there is also 1099-MISC for miscellaneous sources of income. Once you have filled all the forms that apply to your sources of income you can determine your gross income, which is part of the next step.

Step 3: Calculate Your Adjusted Gross Income (AGI)

Once you have your gross income sourced and accounted for, it’s time to make “above-the-line” cuts to it. This means deducting your contributions to things like retirement plan contributions, student loan interest, tuition and other educational expenses, healthcare-related expenses, alimony payments (not child support), and educator expenses, amongst others. Above-the-line deductions help you lower your tax liability by making your AGI smaller, essentially reducing your taxable income.

Step 4: Calculate Your Tax Deductions

As we explained previously in this article, there are two main deductions that you can make to your taxable income: standard and itemized. Standard deduction is a fixed amount based on your filing status: Single, joint filing for married couples, or head of household. Itemized deductions can add up to a bigger deduction than the standard option, but requires extensive documentation of all your deductible expenses.

In short, the standard deduction is more convenient because it saves more time but is beholden to a fixed amount, while itemized deduction is more time-consuming and complex but has the potential to reduce your taxable income even more than the former.

Step 5: Calculate Your Taxable Income

Finally, after all the applicable deductions have been made from your adjusted gross income, the resulting number is your taxable income. It’s very important to be able to calculate your taxable income correctly because it will save you so much hassle down the line.

Common Mistakes When Reporting Taxable Income

Accurately calculating and reporting your taxable income is of utmost importance if you want to avoid penalties, audits and, worst of all, potential legal trouble. The following is a list of the most common mistakes people make when reporting their taxable income, and some tips to avoid them.

1. Misreporting Your Sources Of Income

This is one of the most frequent errors committed by taxpayers. It usually happens when people report their main source of income but overlook smaller ones, including freelance or gig jobs (mostly from online platforms), interest and dividends from investments that are not doing so good, unemployment benefits, and income from rental properties (including Airbnb).  Avoid this small yet bothersome mistake by collecting all applicable tax documents aside from your W-2, such as your 1099s and K-1s, and keep a detailed record of all your additional income through the year instead of scrambling during tax season.

2. Misunderstanding Taxable And Nontaxable Income

Some taxpayers get lost when dividing their total income into taxable and non-taxable, then they end up either over-reporting or under-reporting income. The most common reason for this is believing that absolutely all income is taxable (or, on the other hand, that a few non-traditional income sources are all nontaxable). It’s very important to familiarize yourself with official IRS guidelines on this topic or getting professional guidance for it.

3. Not Keeping Proper Income Records

“Keep your receipts” is more than just a saying, it can save you a lot of time and legal issues come tax season. Not maintaining documents on all your income streams can lead you to misreport your taxable income; also, you won’t have anything to prove what you’re reporting if the IRS questions these sources (even if you’re reporting them correctly). Keep a digital or physical archive of all your tax-related records for each year, there’s even apps that can help you do this.

4. Not reporting “In-Kind” Income

Remember that we mentioned how value gained from bartering is also considered taxable by the IRS? It’s called “in-kind” income, and yes, it should be reported as taxable income, even if it’s performing services in exchange for other professional services. We recommend consulting official IRS guidelines on how to properly report in-kind income in each specific case.

5. Improperly Calculating Adjustments to Income

Both above-the-line adjustments and deductions can be overlooked and cause you to misreport your taxable income. People often miss these because they can be confusing, particularly above-the-line adjustments, which is unfortunate because all of them can significantly reduce your taxable income. Make sure that you don’t miss any credits and adjustments when filing taxes so that you don’t miss on these advantages.

Taxable Income FAQ

 

1. What is taxable income?

Taxable income is the portion of your gross income (or your business’s) that the IRS deems subject to income tax. It is calculated by taking your total income and subtracting deductions, credits, and exemptions.

2. What are some examples of taxable income?

Employee wages and salaries, income from self-employment, rental income, investment earnings and dividends, and even unemployment benefits are all examples of taxable income.

3. What types of income are nontaxable?

Things like gifts, inheritances (at the federal level), life insurance benefits, disability benefits, and alimony payments are some examples of nontaxable income.

4. What is the difference between taxable income and adjusted gross income (AGI)?

Your adjusted gross income (AGI) is the result of subtracting “above-the-line” deductions from your total income (that is, your income from all taxable sources). Then, your taxable income is the result of subtracting further deductions from your AGI, like the standard or itemized deductions.

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