Taxable Income: Understanding How Much You Really Owe
As the old adage goes, no one can escape two things in life: death and taxes. Taxes are one of the biggest, if not the biggest, expense that most people have to deal with each year. It’s a lifelong obligation that can be stressful to think about because of the complexity of the tax system and the amount of calculations and forms involved. Understanding taxable income, however, is crucial in mitigating this stress and ensuring you are paying what you owe.
Taxable income is income that is subject to tax by the government. It includes all types of income, including salaries, wages, profits from businesses, and even gifts. The process of determining your taxable income begins by calculating your gross income. After that, you can make deductions to determine your adjusted gross income (AGI), which is what you use when determining the amount of taxes you owe.
In this article, we will delve into the basics of taxable income and everything you need to know to understand how much you really owe.
What is Taxable Income?
Taxable income consists of income from any source that is subject to taxation by the government. It is the income you report to the Internal Revenue Service (IRS) on your tax return and is used to determine your tax bill. Your tax bill is determined based on your taxable income and the current tax rate.
Taxable income includes all income, including:
– Wages, Salaries, and Commissions: This includes money earned from all forms of work.
– Interest: This includes interest earned from bank accounts and any investments you have.
– Dividends: This includes any dividends received from stocks or mutual funds.
– Capital Gains: This includes any profits made from selling assets such as stocks, bonds, or property.
– Business Income: This includes profits from any self-employment or income earned from running your own business.
– Royalties: This includes income earned from the use of intellectual property, such as patents and rights.
– Alimony: This includes any payments received from a former spouse.
– Rental Income: This includes any income earned from renting out property you own.
– Gambling winnings: This includes any winnings from lotteries, casinos, or other forms of gambling.
What is Not Considered Taxable Income?
While most forms of income are taxable, there are some types of income that are not considered taxable income, such as:
– Gifts: Money or property received as a gift from a family member or friend is not considered taxable income.
– Inheritances: Money or property received as an inheritance is not considered taxable income.
– Life Insurance Proceeds: Money received from a life insurance policy is not considered taxable income.
– Workers’ Compensation: Money received from a workers’ compensation claim is not considered taxable income.
– Scholarships and Grants: Money received as a scholarship or grant is typically not considered taxable income, as long as it is used for qualified educational expenses.
How is Taxable Income Calculated?
Taxable income is calculated by first adding up your total income. This includes wages, salaries, and any additional income, such as interest or dividends. The next step is to subtract any deductions to arrive at your adjusted gross income (AGI).
Deductions are expenses that the government allows you to deduct from your total income. These expenses can either be itemized or you can take the standard deduction. Itemized deductions include things like mortgage interest, charitable donations, and medical expenses. The standard deduction is a set amount that you can deduct from your income regardless of the expenses you had.
Once you have determined your AGI, you can use the tax rates for the current year to calculate your taxable income. Tax rates are percentages that are applied to your taxable income to determine the amount of taxes you owe.
How Does the Taxable Income Tax Rate System Work?
The taxable income tax rate system is a progressive tax system, meaning that the more money you make, the more you will pay in taxes. The system is designed to recognize that those who earn more have a greater ability to pay a larger amount of their income in taxes.
Tax rates change over time, but for the 2021 tax year, the federal tax rates are as follows:
– 10% for taxable income up to $9,950 for single filers and up to $19,900 for married filing jointly.
– 12% for taxable income between $9,951 – $40,525 for single filers and between $19,901 – $81,050 for married filing jointly.
– 22% for taxable income between $40,526 – $86,375 for single filers and between $81,051 – $172,750 for married filing jointly.
– 24% for taxable income between $86,376 – $164,925 for single filers and between $172,751 – $329,850 for married filing jointly.
– 32% for taxable income between $164,926 – $209,425 for single filers and between $329,851 – $418,850 for married filing jointly.
– 35% for taxable income between $209,426 – $523,600 for single filers and between $418,851 – $628,300 for married filing jointly.
– 37% for taxable income above $523,600 for single filers and above $628,300 for married filing jointly.
It is important to note that these tax rates are only federal rates, and each state has its own tax rate structure.
What Factors Can Affect Your Taxable Income?
Several factors can affect your taxable income, including:
– Marital Status: Married couples have higher standard deductions, which can reduce their taxable income.
– Dependents: Having dependents can also reduce your taxable income.
– Retirement Contributions: Contributions to certain retirement accounts, like 401(k)s, can also reduce your taxable income.
– Charitable Contributions: Charitable contributions can reduce your taxable income if you choose to itemize deductions.
– Health Care Expenses: Health care expenses that exceed a certain percentage of your income can be deducted from your taxable income.
– State and Local Taxes: The amount of state and local taxes that you pay can be deducted from your taxable income, up to a certain limit.
– Investment Losses: Losses from investments can lower your taxable income in certain situations.
What Happens if You Don’t Pay Your Taxable Income?
There are severe consequences for not paying your taxable income. You can be subject to fines, interest, and penalties that can add up quickly. If you owe taxes and don’t pay, the IRS can take several actions, including:
– Garnishing your wages
– Placing a lien on your property
– Freezing your bank accounts
– Seizing your assets
It’s important to always pay your taxes on time, and if you are having trouble paying, there are options available, such as payment plans.
Conclusion
Taxes can be overwhelming, and we all know that nobody likes paying them. Understanding your taxable income is a crucial step in ensuring you pay what you owe without overpaying or underpaying. Knowing the ins and outs of taxable income, deductions, and rates can help you stay on top of your tax situation and minimize stress. Always make sure to consult with a tax professional or use official government resources when preparing your tax return to ensure accuracy and compliance with tax laws.
The Difference Between Taxable Income and Nontaxable income
Income can be received in many different forms, for example through money, services, or property. The income can also be described as taxable income or nontaxable income.
Generally speaking, a given amount included in an income is considered taxable unless the income is specifically given an exemption by the law. Taxable income must be reported on the IRS Federal income tax return and is subject by law to tax. Nontaxable income may still have to be shown on a tax return but is not subject to taxes. A complete list of what is considered taxable and nontaxable income can be found in the IRS Publication 525.
Types of Taxable and Nontaxable Income
Constructively-received income
• This is generally considered taxable income and is taxed based on the amount available, even if the money is currently not available, as long as it is before the tax year.
Assignment of income
• Income given by an agent income constructively received during the year the agent received the money.
Prepaid income
• Example: compensation received for future services
• Generally included in the income during the year you received. With an accrual method of accounting, it can be deferred for services to be done prior to the end of next year. The payment is still considered a taxable income.
Employee Compensation
• Generally put into the gross income with salaries, wages, commissions, tips, and fees.
Childcare providers
• This is considered taxable income and a return must include the child’s home or place of business, and the pay received. Self-employed individuals must also include payments for services, Employment implies being subject to the will and controlled by the employer
• Babysitters who sit for family or neighbors are considered child care providers
Fringe Benefits
• Fringe benefits are from performance of services included in the income as compensation unless paid the fair market value by an employee or are specifically exempt by law.
• Refraining from the performance of services is considered the performance of services.
Business and Investment Income
• Rents from personal property: Reporting income from personal rentals are determined by
o If rental activity is a business
o If the rental activity is done for profit.
• If the main purpose is income or profit and is done with continuity and regularity, it is considered business and is taxable income.
Partnership Income
• A partnership is generally not a nontaxable. The income, losses, gains, credits, and deduction of a partnership are put through based on the partner’s share of these items.
S Corporation Income
• An S corporation is generally a nontaxable income. The income, deductions, losses and credits are passed to the shareholders based on the pro rata share. The share is a taxable income and must be reported.
Royalties
• Royalties from patents, copyrights and oil, gas or mineral properties are considered taxable income.
