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Understanding the Difference Between Taxable Income & Non-Taxable Income

Understanding the Difference Between Taxable Income & Non-Taxable Income


This goes for the money you earn and the interest and dividends you earn on your investments. Unless the IRS specifically describes a type of income as non-taxable, you are expected to pay taxes on it.

Here's a quick breakdown of the different forms of income you can receive and whether or not they're generally nontaxable or taxable.


Earned Income

Taxable: You pay taxes on wages, salaries, and tips. Bonuses are also taxable and listed on Form W-2. Money paid "under the table" is taxable even if you don't receive a Form 1099-MISC to report it.

The payment for jury duty may not be very high, but it is still taxable unless you give it to your employer in exchange for your continued salary payment.

Earned income is taxable even if it comes from your favorite hobby. You can deduct expenses from leisure income, but only up to the amount of the leisure income.


Non-taxable: Your employer may provide benefits you do not have to include in your taxable income.

For instance, qualified adoption assistance, the cost of life insurance up to $50,000, child and dependent benefits, and health insurance premiums you pay may not be taxable.


Income paid or given by others.

Taxable: Support payments you receive are considered taxable income. In addition, all court awards received for lost wages and punitive and commercial damages are taxable.

Non-taxable: Gifts, regardless of size, are generally not taxable to the recipient. The donor can also donate up to $14,000 tax-free. Living wages and child support are examples of non-taxable income.

Claims received for injury, illness, or emotional distress. The full amount is not taxable if you have not itemized medical expenses related to the injury or illness in previous years.

However, you must include in income the portion of the medical expense claim you deducted in a previous year to the extent that the deductions provided a tax benefit.


Disability pension and income

Taxable: You pay tax on your retirement and disability income if you haven't already paid tax on contributions or paid premiums to earn income.

You will also pay taxes on withdrawals from an IRA or traditional 401(k) plan since you made pre-tax contributions to the plan. Also, you pay tax on disability benefits for which your employer paid premiums.

Up to 85% of the income you get from Social Security may be taxable if your income exceeds certain levels.


Non-taxable: You do not pay disability income tax if you paid the contributions yourself or if the benefits are linked to the civil service. You also pay no tax on Roth pension plans you have contributed in after-tax dollars.

If you rely primarily on Social Security benefits for your income, your benefits may not be taxable.


Return on investment

Taxable: Interest and dividends are taxable income, except for specific exemptions.

Non-taxable: Municipal bonds are not subject to tax when filed federally. In addition, dividends representing a return on capital are not taxable, unlike dividends representing a share of profits.


Income from the sale of assets

Taxable: Your gain from the sale of the property is generally taxable. Your earnings are usually your base minus the amount you got when you sold it.

For instance, if you buy a stock for $150 and sell it for $250 (after selling costs), you will make a profit of $100 ($250 – 150 = $100). You also pay taxes on gains from the sale of commercial real estate, stocks and bonds, collectibles, investment real estate, and personal items that have been appreciated.

It may be necessary to adjust your basis for other elements. For example, it reduces your basis for any depreciation taken on a business asset. Increase your basis for additional expenses, such as major upgrades.


Nontaxable: One of the big advantages of the tax code is that when you sell your house, you may not be required to pay tax on the first $250,000 of the gain ($500,000 if deposited jointly).

You must have owned and lived in the home for at least two of the last five years for this income to be tax-exempt, and you must not have taken advantage of this exclusion two years prior to the sale of the home.

If you make money from a garage sale, you generally don't need to report the sales since most garage sale items sell for less than their original cost.


Other Income

Taxable: Gambling winnings are taxable. However, you can deduct gambling losses by itemizing your deductions. Note that unemployment benefits are fully taxable.

Nontaxable: If you get an inheritance, it is not subject to tax. The person's estate pays probate and inheritance tax before it gives money to the heirs. But if interest or other income is generated from the inherited money, it is taxable.

Have you ever received income that you thought was not taxable, like unemployment insurance, and later found out you should have included it in taxable income?


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Tiffany Gaskin
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