Types of Income You’re Taxed On & What Is Tax-Exempt
During the year, you may receive income in the form of money, property, or services. This article explains many types of income and whether they are taxable or non-taxable according to the IRS.
Taxable income, generally speaking, is the gross income of an individual or corporation, minus any allowable tax deductions. Your taxable income is, in other words, the amount of your income that is subject to taxation by the government.
In the United States, what qualifies as “taxable income” is defined in the Internal Revenue Code Section 63. “Gross income” is defined in Section 61 of the Internal Revenue Code.
Taxable income can encompass more than just your annual salary. Taxable income can include profits from stocks or real estate sales, winnings from the lottery or from betting on horse races, and winnings from any casino (domestic or abroad). Even the cash value of bartered items is considered taxable income.
Income that may be part of your “gross income” but is not identified as “taxable income” can include child support, proceeds from life insurance policies, inheritances, workers compensation payments, welfare benefits, compensation awarded as a result of physical injury, education scholarships or grants, and income paid to your retirement account (either a 401k or IRA, up to a certain amount).
Tax deductions lower your taxable income. As a taxpayer, you must decide between using itemized deductions or taking the standard deduction. If you claim the standard deduction, you cannot itemize deductions – and vice versa. You are allowed to use whichever type of deduction results in the lowest tax.
Itemized deductions that can minimize your taxable income include: medical expenses, mortgage interest paid on a home loan, personal losses due to theft or accident, state and local taxes, property taxes, charitable contributions to qualified nonprofit organizations, gambling losses (provided they are offset by gambling winnings), and home office expenses.
On the other hand, the standard deduction amount is based on your filing status. For tax year 2018, these amounts are $12,000 for single filers and married couples filing separately, $24,000 for married couples filing jointly and qualifying widow(er)s, and $18,000 for head of household filers. There is an additional standard deduction of $1,300 for blind and elderly taxpayers (those aged 65 or older). Note that the standard deduction amounts often change from year to year.
In summary, taxable income is that portion of your gross income that is subject to taxation by a governing authority, minus any allowable itemized or standardized deductions.
Types of Income Subject to Tax
The following categories represent types of income, which may be subject to Federal/State income tax:
- Wages and salaries
- Tip income
- Interest received
- Business income
- Capital gains and losses
- Pensions and annuities
- Lump-sum distributions
- Rollovers from retirement plans
- Rental income and expenses
- Farming and fishing income
- Earning for Clergy
- Unemployment compensation
- Gambling income and losses
- Bartering income
- Scholarship and Fellowship grants
- Social Security and equivalent Railroad Retirement Benefits
- 401(k) plans
- Passive activities (losses and credits)
- Stock options
- Exchange of Policyholder Interest for stock
- Canceled debt
- Alimony and child support
New for 2019 – There was a repeal of the tax deduction for alimony payments and corresponding inclusion in gross income. According to the IRS, “Alimony received will no longer be included in your income if you entered into a divorce or separation agreement on or before December 31, 2018, and the agreement is changed after December 31, 2018, to expressly provide that alimony received isn’t included in your income. Alimony received will also not be included in income if a divorce or separation agreement is entered into after December 31, 2018.” For more information, see IRS Publication 504 (Divorced or Separated Individuals).
For a complete list of the types of income subject to federal tax, see the IRS Publication 525 (Taxable and Nontaxable Income).
Income That Is Taxable
Here’s a closer look at some categories of taxable income:
Wages, Salaries, and Other Job-Related Earnings – This may include advance commissions, back pays, bonuses, awards, cash gifts from your employer, fringe benefits, unemployment compensation, and childcare services.
Taxable Interest Income – The IRS has defined taxable interest as “any interest you receive that is credited to your account and can be withdrawn.” This may include interest from bank accounts, investment accounts, time deposits, loans you made to others, savings bonds, and debt instruments sold at a discount.
Miscellaneous Income – This may include income from bartering, canceled debts, life insurance proceeds, survivor benefits, recoveries, welfare, and other public assistance benefits.
Other types of taxable income may include: investment dividends income, interest on bonds, alimony, unemployment benefits, Social Security benefits, retirement plan distributions, jury pay, election worker pay, rental income, royalties, notary fees, and certain scholarships, fellowships, and grants.
Income That Is Not Taxable
Types of income that are not subject to Federal tax may include the following:
- Gifts and inheritances
- Life insurance proceeds
- Child support
- Certain Veteran’s benefits
- Insurance reimbursements for medical expenses not previously deducted
- Some welfare payments
- Compensatory damages for personal physical injury or illness
- Workers’ compensation
- Some qualified pension distributions for Public Safety Officers
For more information about income that is exempt from tax, see the IRS Publication 525 (Taxable and Nontaxable Income).
Taxable Income for Self-Employed Individuals
Self-employment tax (also called “SE tax”) is a Social Security and Medicare tax aimed mainly at individuals who are self-employed. The SE tax payments you make go towards your coverage under the federal Social Security system. Social Security coverage essentially provides retirement benefits, disability benefits, health care benefits (Medicare), and survivor benefits.
In general, you must pay Self-Employment Tax and file “Schedule SE” (on Form 1040) if either of the following applies:
- Your net earnings from self-employment income were $400 or more
- You have church employee income of $108.28 or more
Your net earnings from self-employment income are generally subject to SE tax. If you’re self-employed as an independent contractor or sole proprietor, you can use Schedule C or Schedule C-EZ to calculate your net earnings from self-employment.
To pay self-employment tax, you must have a Social Security number (SSN) or an individual taxpayer identification number (ITIN).
Note that there are special rules for fishing crew members, notary public employees, aliens, state or local government employees, foreign government employees, and international organization employees.
You should also note that whenever SE tax is mentioned, it generally only refers to Social Security and Medicare taxes, and does not include any other taxes that self-employed individuals may be subject to. Keep in mind that other information may be required for your particular type of business.
Self-Employment Tax Rate
The SE tax rate for calendar year 2018 is 15.3% — which breaks down to12.4% for Social Security (old age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
For tax year 2018, the first $128,400 of your combined earnings may be subject to a combination of railroad retirement (tier 1) tax, Social Security tax, and the Social Security part of self-employment tax. Any income you earn over $128,400 will not be subject to the Social Security tax.
All of your combined earnings in the current year may be subject to any combination of the Social Security tax, the 2.9% Medicare port of self-employment tax, or railroad retirement (tier 1) tax.
If your wages (including tips) are subject to Social Security tax and/or railroad retirement (tier 1) tax, and your wages are at least $128,400, you may not be subject to the Social Security part of the self-employment tax on any of your net earnings. Regardless, you must still pay the Medicare part (2.9%) of the self-employment tax on all of your net earnings.
If you do not file based on the calendar year, you must use the tax rate and earnings limit that is effective at the beginning of your tax year. Even if the tax rate and/or earnings limit changes during the year, you must continue to use the same rate and limit throughout your entire tax year.
Keep in mind, the self-employment tax rules apply regardless of your age – even if you have already begun receiving Social Security or Medicare benefits.
For more information, please refer to IRS Publication 334 (Tax Guide for Small Business) and IRS Publication 17 (Your Federal Income Tax For Individuals).