What is taxable income?
Taxable income is the portion of your income that is subject to taxes. This, of course, will be after factoring in deductions and exemptions. Many people do talk about taxable income or paying taxes in general. But tax planners who save a lot of money on taxes do know the different types of income, which helps them plan and strategize their taxes and save thousands of dollars each year. Knowing about taxable income alone is not enough because it is like the apex of a process that involves a few other income types. You must adjust the types of incomes that build up to taxable income to save money on taxes. But can you plan to adjust what you do not know about? I guess not. If you intend to save money on taxes, you must also understand the income types discussed for tax purposes. Below, we discuss Earned Income, Gross Income, and Adjusted Gross Income.
Earned income
An individual taxpayer’s tax bracket is determined by their earned income. And earned income is the first you need to understand because that is the income that encompasses everything you earn – without deducting a cent.
Individuals earn income via wages, tips, or fringe benefits. Even if you are not employed and provide services such as babysitting or childcare and receive payment for that, you are considered self-employed and must complete Schedule C (Form 1040 or 1040-SR), Profit or Loss From Business.
On the other hand, business income is earned from providing services to customers as well as interest or gains from invested income or trade. Examples of earned income from investments include rental income, royalties from copyrights, patents, oil, gas and mineral properties, and buying and selling of virtual currencies.
Besides the above means of business income, there is also Bartering. This is the exchange of goods and services for other types of goods and services without involving money.
Gross Income
Gross income is more like your earned income. It is the total income you receive before deducting any taxes or expenses. If you are an employee, you see this all the time on your paycheck. Important to note is the fact that your gross annual income (gross income for the entire tax year) includes income from all sources. If you are employed and run a side hustle, maybe landscaping during the weekends, you must include landscaping income on your tax return. If you also rent a property or own an Airbnb, you must also include this income to arrive at a gross annual income.
For businesses, this is called gross margin or gross profit. This is found by subtracting the cost of goods sold from the company’s total revenue.
Adjusted Gross Income (AGI)
Your AGI is calculated directly from your gross income. Doing this makes you arrive at your taxable income. Therefore, it is essential to pay attention to these types of income.
The internal Revenue Service (IRS) uses your AGI to determine the income tax you owe. Your AGI is arrived at by subtracting certain amounts from your gross income. These adjustments include business expenses, student loan interest payments, and other expenses.
After subtracting the above expenses, you may subtract certain deductions to arrive at your total taxable income. These deductions could be the standard deduction or itemized deductions. After deducting them, the IRS will then calculate the taxes you owe.
To note is the fact that you do not subtract tax credits from this taxable income. This is because tax credits subtract from the actual tax you owe, dollar for dollar. Therefore, you must subtract them directly from your taxes owed, NOT from your taxable income.
The Bottom Line
To pay less taxes, you must know the above types of income. Knowing them alone is not enough, but you must also go ahead and implement strategies to adjust them until your taxable income is so small that the IRS can only ask you to pay almost nothing. To adjust these incomes, you must use itemized deductions and ensure that you qualify for tax credits you are eligible for. Individual taxpayers can itemize tax deductions such as unreimbursed medical expenses, charitable donations, and interest on mortgage payments. They can also take advantage of tax credits such as the earned income tax credit and the child tax credit.
Businesses can reduce their tax bills by taking advantage of tax write-offs such as meals, work travel, business insurance, and home office expenses, among others.
People have also asked the following questions
1. How do I calculate my taxable income
Start by determining your filing status, for example, married filing jointly. Determine your type(s) of income before calculating your expenses and deductions.
2. What types of income are taxable?
Common taxable types of income are wages, tips, business income, and profits from investments
3. What income is not taxable?
An example of nontaxable income is income from inheritance and gifts, among others.
4. What are 3 types of taxes?
Three types of taxes are payroll tax, sales tax, and income tax.
5. What is the minimum taxable income?
The minimum taxable income depends on your filing status. For example, if you have a single filing status, your minimum income to file taxes is $12,400 for under age 65 and $14,050 for 65 or older. If you are married and filing separately, the minimum income you have to make to file taxes is $5 for all ages.
