Whether this tax season is your first or you’ve been navigating it for years, you might still have questions about your taxable income—what it is and how to calculate it. Maybe you transitioned from standard wages to freelancing, had some lotto winnings, or started your first waitressing job and are curious about how much of your tip money is taxable.
In essence, nearly all income you receive throughout the year is considered taxable income. This includes paychecks, compensation for freelance work, and passive income from investments. It’s not just about the total amount you receive, though. Deductions play a crucial role by lowering your total taxable income, which ultimately affects how much you owe in taxes.
If You’re Paid for Work, That’s Taxable Income
The first thing to understand about taxable income is that any payment you receive for your work is subject to taxes. This includes your salary, hourly wages, tips, and earnings from freelance work.
If you have an employer, they typically handle the tax calculations and withhold the necessary amounts from your paycheck, making it easier for you come tax time. However, they won’t do this for any side gigs or investments you have. It’s also important to note that bonuses are considered taxable income.
For freelancers, the process is a bit more complex. You’ll need to set aside money for your own quarterly and yearly taxes.
Investments, Winnings, and Certain Windfalls
When you receive a significant influx of money, it’s generally safe to assume it’s taxable, with some exceptions.
Investment income is taxable. This includes rental payments, profits from real estate sales, stock dividends, and other passive investments. Gambling winnings, royalties, and unemployment compensation are also considered taxable income.
A notable change for 2021 is that gains from Bitcoin and other virtual currencies are now considered taxable income. Your 2021 tax form includes a question regarding your holdings or gains from cryptocurrency. This reflects the growing importance of cryptocurrencies like Bitcoin in Americans’ financial lives.
But What Isn’t Taxable Income?
While most of your yearly cash flows are taxable, there are important exceptions that could save you stress. Examples of non-taxable income include:
- Life insurance payouts
- Welfare and veterans benefits
- Inheritance
- Scholarships
- Child support
- Up to $250,000 in gains from selling your primary residence ($500,000 if you’re married)
This is not an exhaustive list, so if you receive a sudden influx of cash, it’s always wise to double-check whether it’s taxable.
Deductions
Deductions are like magic for your taxes: they reduce your taxable income, resulting in you paying less. However, many people aren’t sure what they can claim. Common deductions include:
- Charitable donations
- Student loan interest
- Teacher educational expenses
- Gambling losses (up to the amount of gambling gains)
- Real estate and property taxes (subject to the $10,000 state and local taxes cap)
- Moving expenses (only for military personnel required to move at least 50 miles away)
- Medical and dental expenses
- Health savings accounts (HSAs)
- Sale of personal residence
- Business expenses
Self-employed individuals often find it easier to navigate deductions, as the rules for what can be claimed as a business expense are broader. This includes office supplies, technology, and other work-related items, which help lower taxable income.
For a comprehensive list of tax deductions for individuals, you can refer to IRS resources or consult a tax professional.
Always Double Check, Always Deduct Where You Can
Some people genuinely enjoy doing their taxes, and if you earn enough, you might outsource the task to an accountant. However, for most of us, it can be a confusing and daunting process. It can even be a bit embarrassing to admit we don’t fully understand everything. Even if you don’t want to become a tax expert, having a basic understanding of your taxable income can save you money or at least prevent the shock of owing unexpected taxes to the IRS.