Knowing what to claim as taxable and nontaxable income can reduce your tax liability. Here's what you should know.
Key Takeaways
• Income received as wages, salaries, commissions, rental income, royalty payments, stock options, dividends and interest, and self-employment income are taxable. Unemployment compensation generally is taxable.
• Inheritances, gifts, cash rebates, alimony payments (for divorce decrees finalized after 2018), child support payments, most healthcare benefits, welfare payments, and money that is reimbursed from qualifying adoptions are deemed nontaxable by the IRS.
• Money from a qualified scholarship isn't taxable, but if you use the money for room and board or to pay other personal expenses, that portion is normally taxable.
• Miscellaneous income is taxable. This can include the remaining amount of a debt or loan that is canceled, employer contributions to an unqualified retirement plan, and sickness, injury, and disability retirement payments from an employer-paid plan.
What's not taxable
Nontaxable income won’t be taxed, whether or not you enter it on your tax return. The following items are deemed nontaxable by the IRS:
- Inheritances, gifts and bequests
- Cash rebates on items you purchase from a retailer, manufacturer or dealer
- Alimony payments (for divorce decrees finalized after 2018)
- Child support payments
- Most healthcare benefits
- Money that is reimbursed from qualifying adoptions
- Welfare payments
Under certain circ*mstances, the following items may be nontaxable. TurboTax can help you determine what should be included in your return.
- Money you receive from a life insurance policy when someone dies is not taxable. However, if you cash in a life insurance policy, then a portion, if not all of it, is likely taxable.
- Money from a qualified scholarship is not taxable. However, if you use the money for room and board, or use it to pay other personal expenses, that portion is normally taxable.
Compensation
Generally, income can be received in three ways: money, services and property. But, you can also pay tax on income not yet in your bank account. For example, if you receive a check but don’t cash it by the end of the tax year, it is still considered income for the year you received the check.
The IRS requires that you declare all income on your return. This can include:
- Wages
- Salaries
- Commissions
- Strike pay
- Rental income
- Alimony (for divorce decrees finalized before 2019)
- Royalty payments
- Stock options, dividends and interest
- Self-employment income
Typically, unemployment compensation is also considered taxable income. However, for the 2020 tax year, up to $10,200 of unemployment benefits can be excluded from income. If you are married, each spouse can exclude this amount. Amounts over this remain taxable and if your modified adjusted gross income (AGI) is greater than $150,000 then you can't exclude any unemployment compensation.
TurboTax Tip: Fringe benefits received for services you render are usually considered taxable income, even if someone else receives them, such as your spouse. Taxable benefits may include a company-paid off-site gym membership, a company vehicle for personal use, and holiday gifts from your employer.
Income from fringe benefits
If you receive fringe benefits for services you render, they are usually considered taxable income, even if someone else receives them, such as your spouse. These taxable benefits and perks may include:
- A company-paid off-site gym membership
- A company vehicle for personal use
- Holiday gifts in the form of cash or gift certificates from your employer
- A certain portion of employer-paid dependent care
- Company-paid tuition fees over a certain amount
- Company-paid financial counseling fees
- Employer-paid group life insurance over a certain amount
Miscellaneous income
Income that may not be readily identified as taxable but generally must be included on your tax return includes:
- Employer contributions to an unqualified retirement plan
- The fair-market value of property received for your services
- Disability retirement payments from an employer-paid plan
- Sickness and injury payments from an employer-paid plan
- Property and services for which you bartered
- Money and income from offshore accounts
- The remaining amount of a debt or loan that is canceled or forgiven
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FAQs
Generally, an amount included in your income is taxable unless it is specifically exempted by law. Income that is taxable must be reported on your return and is subject to tax. Income that is nontaxable may have to be shown on your tax return but is not taxable.
What is the difference between taxable income and nontaxable income? ›
Non-taxable income is income that is not subject to tax by the government. Most common tax-free income are gifts and government need-based benefits. You are not required to report non-taxable income on your tax return. If you choose to report it, it will not affect your tax liability or tax refund.
What 3 things must you know to determine your taxable income? ›
- Step 1: Determine Your Filing Status. First, determine your filing status. ...
- Step 2: Consider Your Types of Income. The IRS requires you to report all of your income. ...
- Step 3: Calculate Deductions and Taxable Income.
Gross income includes all income you receive that isn't explicitly exempt from taxation under the Internal Revenue Code (IRC). Taxable income is the portion of your gross income that's actually subject to taxation. Allowable deductions are subtracted from gross income to arrive at your taxable income.
How do you calculate taxable and non taxable income? ›
For individual filers, calculating federal taxable income starts by taking all income minus “above the line” deductions and exemptions, like certain retirement plan contributions, higher education expenses, student loan interest, and alimony payments, among others.
How do I know if I have non taxable income? ›
Nontaxable income won't be taxed, whether or not you enter it on your tax return. The following items are deemed nontaxable by the IRS: Inheritances, gifts and bequests. Cash rebates on items you purchase from a retailer, manufacturer or dealer.
What qualifies as taxable income? ›
Taxable income includes wages, salaries, bonuses, and tips, as well as investment income and various types of unearned income.
How do you prove taxable income? ›
How to Provide Proof of Income
- Annual Tax Return (Form 1040) This is the most credible and straightforward way to demonstrate your income over the last year since it's an official legal document recognized by the IRS. ...
- 1099 Forms. ...
- Bank Statements. ...
- Profit/Loss Statements. ...
- Self-Employed Pay Stubs.
Money earned through a salary, wages, and self-employment income are some of the most common types of taxable income. Other types include royalties, commissions, rental income, and strike pay.
Is 401k taxable income? ›
Traditional 401(k) plans are tax-deferred. You don't have to pay income taxes on your contributions, though you will have to pay other payroll taxes, like Social Security and Medicare taxes. You won't pay income tax on 401(k) money until you withdraw it.
Income excluded from the IRS's calculation of your income tax includes life insurance death benefit proceeds, child support, welfare, and municipal bond income. The exclusion rule is generally, if your "income" cannot be used as or to acquire food or shelter, it's not taxable.
What is the difference between taxable income and earned income? ›
What is Earned Income? Earned income includes all the taxable income and wages you get from working or from certain disability payments. Taxable earned income includes wages, salaries, tips, and other taxable employee pay.
What is the difference between total tax and taxable income? ›
Total tax makes up all the taxes you owe over a year. Total tax is how the IRS figures out to see if you need a refund or if you owe the government money. Deductions lower your taxable income.
What is the difference between taxable and nontaxable income? ›
Generally, an amount included in your income is taxable unless it is specifically exempted by law. Income that is taxable must be reported on your return and is subject to tax. Income that is nontaxable may have to be shown on your tax return but is not taxable.
What are the four steps to calculating your taxable income? ›
Here are the four steps:
- Step 1: Determine your filing status. ...
- Step 2: List all forms of your taxable income. ...
- Step 3: Calculate adjusted gross income (AGI) ...
- Step 4: Subtract deductions from AGI to determine taxable income.
Tax-exempt income is income from any source which the Federal, state, or local government does not include when implementing its income tax. Individuals and organizations may have to report this income on a tax return, but the income will not be considered when determining their tax liability.
Is it bad to have no taxable income? ›
Any year you have minimal or no income, you may be able to skip filing your tax return and the related paperwork. However, it's perfectly legal to file a tax return showing zero income, and this might be a good idea for a number of reasons.
What is the difference between taxable income and taxable liability? ›
Your taxable income minus your tax deductions equals your gross tax liability. Gross tax liability minus any tax credits you're eligible for equals your total income tax liability. But before you can start crunching numbers, you need to understand your entity type. That will affect how you calculate your taxes.
