Taxable Income

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Taxable Income: What It Is, What Counts, and How to Calculate

What is taxable income?

Taxable income is the portion of your gross income that is subject to income tax. It equals your adjusted gross income (AGI) minus either the standard deduction or allowable itemized deductions. Taxable income includes both earned (wages, salaries, tips) and unearned income (interest, dividends, capital gains, certain government benefits, canceled debt, lottery winnings, etc.). Tax brackets and marginal tax rates are applied to taxable income, not gross income.

Key takeaways

  • Taxable income = AGI − (standard deduction or itemized deductions).
  • It includes earned and most unearned income.
  • Businesses calculate taxable income by subtracting business expenses from revenue, then applying deductions.
  • Reducing AGI or claiming allowable deductions lowers taxable income and tax liability.

Sources of taxable income

Common sources include:
* Employee compensation: wages, salary, tips, bonuses (reported on Form W-2). Employer-provided fringe benefits may be taxable.
Self-employment, business, and rental income: revenue minus allowable business expenses yields business income. Rental receipts are taxable, though related expenses can offset them.
 Pass-through entities: partnerships and S corporations pass income, losses, and deductions through to owners or shareholders, who report them on personal returns.
Investment and unearned income: interest, dividends, capital gains, royalties, and certain government benefits (unemployment, some disability payments).
 Other items: bartered goods and services, digital-asset transactions (sales, exchanges), forgiven debt (in many cases), and gambling or lottery winnings.

How to calculate taxable income (step-by-step)

  1. Determine filing status
    Choose the correct filing status (single, married filing jointly, married filing separately, head of household) — this affects the standard deduction and tax rates.

  2. Gather income documents
    Collect W-2s, Form 1099-NEC (nonemployee compensation), 1099-MISC, 1099-INT (interest), 1099-DIV (dividends), K-1s (partnership/S-corp pass-throughs), and records of other income.

  3. Compute gross income and AGI
    Add up all taxable income sources to get gross income. Apply allowable “above-the-line” adjustments (e.g., certain IRA contributions, student loan interest, educator expenses) to get AGI.

  4. Choose and calculate deductions
    Decide whether to take the standard deduction (based on filing status) or itemize. Common itemized deductions include:

  5. Mortgage interest (Form 1098)
  6. State and local taxes (subject to limits)
  7. Charitable contributions (subject to AGI limits)

  8. Unreimbursed medical expenses that exceed the applicable AGI threshold (often 7.5% of AGI)
    Eligible owners of sole proprietorships, partnerships, and S corporations may qualify for the Qualified Business Income (QBI) deduction (up to 20% of QBI subject to rules).

  9. Subtract deductions from AGI
    Taxable income = AGI − (standard deduction or itemized deductions). Apply any applicable tax credits after computing tax on taxable income.

Notes and examples

  • Tax brackets apply to taxable income; reducing taxable income can lower the marginal tax rate applied to some of your income.
  • Bartered services: the fair market value of exchanged goods/services is taxable.
  • Digital currency: sales, exchanges, and income from crypto transactions generally create taxable events.
  • Pass-through entities: partnerships and S corporations generally don’t pay entity-level income tax; income and deductions flow to owners’ returns.

Taxable vs. nontaxable income

Most income is taxable, but some items are excluded from gross income or otherwise nontaxable. Examples of commonly nontaxable items include:
* Certain employer-provided fringe benefits that meet exclusion rules
Life insurance proceeds paid upon someone’s death (generally nontaxable to beneficiaries)
 Qualified gifts and some transfers back to a religious or charitable organization under specific circumstances

Rules vary by jurisdiction (for example, some countries treat lottery winnings differently), so verify local tax law for exclusions and exceptions.

Ways to lower taxable income

  • Contribute to pre-tax retirement plans (401(k), traditional IRA) to reduce AGI.
  • Use employer-provided tax-advantaged accounts (health savings accounts, flexible spending accounts).
  • Maximize above-the-line adjustments (student loan interest, educator expenses, self-employed health insurance).
  • If beneficial, itemize deductions and document deductible expenses (mortgage interest, state/local taxes within limits, charitable gifts).
  • For eligible small-business owners, explore the QBI deduction and legitimate business expense deductions.

Bottom line

Taxable income determines how much tax you owe. It’s important to identify all taxable sources, claim allowable adjustments and deductions, and choose the filing approach that minimizes tax liability. Keeping organized records and understanding applicable exclusions and credits will make filing more accurate and may reduce your tax bill.