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Taxable Income: What Is It and How Is It Determined?

Published March 15, 2021

4 minute read

Cora Walker

By Cora Walker

Whether this tax season is your first or you’ve been doing this adulting thing for a few years, you might still have questions about your taxable income. Including what it is, and how to calculate it. Perhaps you switched from one income type to another, like from standard wages to freelancing. Maybe you were even lucky enough to have some lotto winnings this year. Did you score your first waitressing job and are wondering how much of your tip money gets set aside?

In short, pretty much all regular income you receive during the course of the year is taxable income. This includes your paychecks, compensation for any freelance work you did, or any passive income from your investments. It’s not just the total amount of money you receive, though. Deductions matter because they lower your total taxable income. This impacts how much you pay in taxes.

If You’re Paid for Work, That’s Taxable Income

The first stop on the taxable income train is to know that any payment you receive from your employer or business paying you for your service is taxable income. So your salary, hourly wage, tips, and freelance work are all subject to taxes.

If you have an employer, it’s a straightforward process. They typically calculate taxes for you and withhold them from your paycheck. They obviously won’t do this for any side-gigs or investments you have, though. But it’s one way the business you work for can take the pressure off come tax time. A quick note that bonuses are also taxable income.

Things get a little more complicated for freelancers, and you will need to set aside your own quarterly and yearly taxes.

Investments, Winnings, and Certain Windfalls

When you get a huge influx of money suddenly, it’s safe to consider it taxable (with some notable exceptions).

Investments are part of your taxable income. That includes rent payments you received, profits from real estate sales, any stocks you own, or any other passive investments you might have. Winnings from any gambling activities are also considered taxable. Royalties and unemployment compensation are also considered taxable.

Important change for 2021: Bitcoin and other virtual currency gains are considered taxable income. A question has been added to your 2021 tax form that you must answer if you have any holdings or gains from the cryptocurrency market. Take a look at these cryptocurrency statistics to understand how quickly Bitcoin and other cryptocurrencies have risen to normal mainstays in American’s tax returns.

But What Isn’t Taxable Income?

Okay, we just said that most of your yearly cash flows are taxable. That is still true. But there are some really important exceptions to be aware of that could save you stress. A few examples of non-taxable income include (but are not limited to):

Deductions

It’s a magic word: deductions. And like magic, deductions decrease your taxable income. The result? You end up paying less in April, but people don’t always know what they can claim as a deduction. Generally, deductions include things like:

Things do get a little easier here for self-employed people. If you are operating your own business, the rules for what you can claim as a business expense are broad. Business expenses mean deductions, which means lowering your taxable income. There are some restrictions on this, but it does mean that you can deduct things like office supplies, technology, or other work items.

You can find a full list of tax deductions for individuals here.

Always Double Check, Always Deduct Where You Can

There are some people out there who love doing their taxes. If you make enough money, you may even outsource the job to an accountant to handle them for you. For most of us, it can be a confusing experience. It can also be, well, embarrassing to admit we don’t fully understand something. Even if you don’t want to know all the forms inside and out, understanding your taxable income can save you money. Or at least save you from wincing when you realize you owe the IRS money you didn’t plan on needing to pay.

Tax Return Taxable Income

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Cora Walker

Cora Walker

Contributor

Cora is a Northwest-based writer and editor who wants to make information as accessible as possible in the internet age. Video games are this writer’s primary vice. With a degree from the University of Washington as well as 5+ years of experience in web writing and publishing, Cora is here to share financial tips from experts and talk about good habits.

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