Taxes owed to Uncle its Sam are well-known for their complexity. While taking stock of all taxable income types may seem like an easy and straightforward exercise, it’s often not the case. Taxable income is not always clear-cut, even for salaried employees. It is very confusing to know which type of incomes falls into the taxable and non-taxable categories.
Taxable Income
What is taxable income? The question is not easy to answer as it might seem. An ‘income’ means a lot more than to the IRS than just merely salary, wages, gifts, and bonuses. Taxable income is generally referred to as gross income or adjusted gross income which is without any deductions or exemptions allowed in a particular tax year.
Breaking down taxable income
Here are some of the types of taxable income:
- Salaries, wages
- Pensions
- 401(k) plans
- Lump-sum distributions
- Interests and Dividends
- Rental income and expenses
- Capital gains
- Extension or transfer of retirement plans
- Royalties
- Embezzled money. That’s right! If convicted, taxes are owed on the amount stolen for the tax year in which money was stolen.
- Awards, prizes and winning contests
- Freelance income
- Profits on sale
Taxable income which comes under unearned category includes canceled debt, benefits such as disability and unemployment, lottery payments and strike benefits. Earnings generated from appreciated assets that have been capitalized or sold during the year also come under taxable income.
The salary after tax calculator provides an estimate of the tax owed to the government and take-home income.
Non-taxable income
The U.S. Internal Revenue Service (IRS) considers a small number of income streams are considered nontaxable.
Here is the list of taxes taxpayers don’t to Uncle Sam are:
- Life insurance proceeds. The insurance policy death benefit is not taxed to the beneficiary.
- Gifts. Money received as a gift is not taxable; however, any income made from the gift is taxed by the IRS.
- Inherited assets. Except to the extent that assets would have been taxed to the person inherited from.
- Scholarships as well as fellowship grants not taxed.
- Federal income tax return. The money got back from the US government is not taxed.
- Accidents injury awards. Compensatory damages are given to personal physical injury or illness.
- Worker compensation. The payments as recompense paid to the workers are not taxed.
Deductions Affecting Taxable Income
It is worth noting that deductions can reduce taxable income. The standard deduction is a fixed amount each taxpayer can claim depending on the filing status, age and other factors. The IRS also offers itemized deductions to the taxpayer such contributions to IRAs (individual Retirement Accounts), interest paid on mortgages, few medical expenses, and some other expenses.
Business while filing their taxes does not report revenue as income; instead, they subtract the business expenses from the revenue and calculate their business income. Then they subtract the deductions from the business income to calculate the taxable income.
Lower the Taxable Income
Want to pay less to the IRS? Who doesn’t? There are legal ways to reduce the amount of money sent to the government without being accused of tax evasion.
Taking guidance from a tax professional or using tools such as salary after tax calculator, paycheck calculator, and other software. Some taxpayers do not report their full income, maybe because they do not understand the 1099 form or other related tax documents. However, each person is responsible for their income and regardless of the tax documents, they need to report their income to the IRS and failing to do so can increase the amount of money owed to the government.
Some of the tips to lower taxable income are:
- Contribute as much as possible to the retirement accounts.
- Take the benefit of tax-loss harvesting and reduce the taxable income up to $3000.
- Maintain a qualifying health insurance plan or end up paying penalties in the form of taxes.
- Invest in Health Savings Account (HAS) if the taxpayer fulfills the eligibility criteria of a high deductible health plan.
- Taxpayers with kids can save college funds for the future.
- Make charitable contributions
- Buying a house is a major decision but it can reduce the tax bill in the right situations.
Taxes are undoubtedly unpleasant, but a little knowledge about them can make them bearable. It is better to know the taxable and non-taxable income rather than keep guessing them. Be smart while paying taxes. Estimate your tax return regularly and ensure you retain sufficient funds to pay your annual tax return. Using free online tax form calculators and tax software can help you do this with the minimum of fuss and no out of pocket costs.
