Taxable Income: Definition, How to Calculate It
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Understanding how much you may owe in taxes means keeping track of a lot of different numbers and terms. One of the most important numbers is taxable income: the amount of money on which you have to pay income tax.
Here’s what to know about taxable income, how to calculate it and some basic strategies for reducing it.
What is taxable income?
According to the IRS, most income is taxable unless it is tax-exempt by law. Taxable income can take the form of earned income, such as wages and salaries, as well as unearned income, such as profits from the sale of investments or property.
Some common types of taxable income include, but are not limited to:
Employment income (i.e., wages reported on Form W-2).
Freelance or independent contractor income reported on Form 1099.
Rental income.
Business income.
Investment income, including capital gains, dividends and interest.
Benefit payments such as distributions from traditional retirement plans, unemployment benefits and Social Security payments (depending on income).
Some types of canceled debt (the amount forgiven is treated as income).
Alimony payments (for the beneficiary).
Tax refunds and rebates.
Gambling winnings.
Taxable income vs. nontaxable income
There are certain types of income that are federally nontaxable by law. A nonexhaustive list of types of nontaxable income generally includes:
Life insurance payouts.
Qualified Roth IRA and Roth 401(k) distributions.
Health savings account (HSA) withdrawals for qualified medical expenses.
Employer-provided insurance benefits.
Most municipal bond interest.
Gifts are something of a special case: They are not taxable income for the recipient, but the giver may be subject to gift tax if they’ve exceeded their lifetime gift tax exclusion.
» Learn more: 14 types of nontaxable income
Certain kinds of nontaxable income, such as municipal bond interest, may not be taxed but can be included in the calculation of modified adjusted gross income (MAGI), a number that helps the IRS determine whether you're eligible for certain tax credits or benefits.
How to calculate taxable income
Determining your taxable income starts with knowing your gross income, which is the sum of all the money you received throughout the year. You’ll then have to figure out which of the five tax statuses apply to you. Choosing the right one is important because your status dictates your tax brackets and rates, which tax benefits you may be eligible for and how much you may be able to subtract from your income via certain deductions.
Once you have your gross income, you’ll need to figure out what your adjusted gross income (AGI) is. Your AGI is equal to your gross income minus certain “above-the-line” deductions that are available to all taxpayers.
Some examples of above-the-line deductions:
Contributions to traditional IRAs and 401(k)s.
Student loan interest payments.
Alimony payments (for the payer).
After this, taxpayers can further reduce their taxable income in one of two ways — via the standard deduction or itemizing. Most taxpayers claim the standard deduction, a preset amount of money they can subtract from their AGI. For tax year 2024 (taxes filed in 2025), it will be $14,600 for single filers, $21,900 for those filing as head of household and $29,200 for married couples filing jointly.
Itemized deductions, on the other hand, are deductions you can take for specific IRS-approved expenses. If a taxpayer has enough of these expenses that the value exceeds what they would get through the standard deduction, they can consider this option.
What’s left over after this process is your taxable income.
» Estimate your bill or refund with our income tax calculator.
How to reduce taxable income
You can reduce your taxable income by contributing to certain tax-advantaged accounts or by claiming additional deductions.
For example, if a 401(k) account is available to you via an employer, you can contribute up to $23,000 of your income ($30,500 for those 50 and older) in 2024 to this retirement savings vehicle. This, in turn, would lower your taxable income by $23,000 if you contributed the maximum amount. Even if you’re not a W-2 worker, there are plenty of self-employment retirement accounts available with similar tax advantages.
Another option for reducing your taxable income is to consider itemizing. This deduction strategy might be a good fit for taxpayers who have enough specialty deductions to make passing up the standard deduction worthwhile. Some of the most well-known itemized deductions include:
SALT deduction: Up to $10,000 in state and local income, sales or property tax payments.
Mortgage interest deduction: Interest payments on up to $750,000 of mortgage debt from their first or second home ($375,000 if married filing separately).
Charitable donations deduction: Money or goods donated to qualified organizations worth up to 60% of AGI.
» Tax planning basics: 7 strategies to consider
Bottom line
In short, taxable income is equal to adjusted gross income (AGI) minus standard or itemized deductions. Here is a slightly more detailed formula:
Taxable income = gross income - (nontaxable income + above-the-line deductions + standard deduction or itemized deductions).
If this feels too hard to do by hand, don’t worry. There’s a variety of tax-filing software out there that can make these calculations easier.
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