Taxable income—what is it and how does it affect your taxes?

Most types of income are taxable based on IRS rules. This includes money you make from a job or self-employment, investment income, unemployment pay, lottery winnings, and many other income sources.

Only a few types of income are not taxable at the federal level. But IRS deductions, credits, and other adjustments can help reduce your taxable income and total tax bill.

What's taxable and what's not?

Here are some of the most common types of taxable and nontaxable income. For more help determining what to report on your taxes, talk to a tax professional Tooltip Professionals licensed to give tax advice and help with tax planning include Certified Public Accountants (CPAs), Enrolled Agents, and tax attorneys. Since state and local tax laws vary, it's best to look for a tax professional with experience in your local area. or visit www.IRS.gov.

Taxable (earned, unearned, and other)

• Wages, salary, tips, commissions, and bonuses
• Self-employment income
• Union strike benefits
• Certain disability payments
• Unemployment pay
• Other taxable employee compensation
• Rental income
• Retirement account withdrawals
• Social Security income (up to a certain percent, depending on your total income)
• Pension income
• Capital gains, dividends, and interest
• U.S. savings bonds
• Prize, gambling, and lottery winnings
• Alimony payments (if the divorce was final before 2019)

Nontaxable

• Gifts or inheritances you receive
• Child support
• Life insurance proceeds (after the insured person's death)
• Interest from municipal bonds (may be subject to alternative minimum tax and state tax for out-of-state bonds)
• Disability income (if you paid the premium with after-tax dollars)
• Certain employee benefits

This list is not all inclusive.

How does your taxable income affect your taxes?

While most income must be reported on your taxes, the IRS allows you to make certain adjustments and exclusions to reduce your taxable income. Your final taxable income and tax bill are determined only after all allowed deductions and other adjustments are subtracted from your gross income.

All of the taxable income you receive for the year. You'll report it on your tax return (Form 1040). It includes all of your earned income, unearned income, and other taxable income before any deductions, credits, or other adjustments are subtracted.

Your gross income minus any above-the-line deductions Tooltip Above-the-line deductions are subtracted from your gross income to help calculate your adjusted gross income (AGI). They do not include itemized deductions or the standard deduction. Examples of above-the-line deductions include Health Savings Account contributions, deductible self-employment taxes, educator expenses, student loan interest, and others. you qualify for. Once your AGI is calculated, the IRS subtracts your standard deduction Tooltip The standard deduction is a specific amount that the government allows you to subtract from your taxable income. The exact amount of your standard deduction depends on your filing status, and can change from year to year depending on the current tax laws. or itemized deductions Tooltip If you itemize deductions, you'll report them on Schedule A. Some expenses that can be itemized are certain medical and dental payments, investment interest expenses, up to $10,000 in state, local, and property taxes, and a portion of your mortgage interest. Certain deductions (like student loan interest) do not require itemizing. from it to determine your final taxable income (the amount you'll actually pay taxes on).

Another income calculation you might hear about. It doesn't appear on your main tax form, but the IRS uses it to determine your eligibility for certain tax credits, as well as net investment income tax. It's your AGI with certain deductions or income added back in.

How does your final taxable income affect your tax bill?

Your final taxable income determines your tax bracket and tax rate. But all of your income isn't taxed at one flat rate. Instead, it's taxed in a graduated manner.

Here's an example:

Let's say you're a single filer. Your AGI for 2022 is $80,000 and your final taxable income after your standard deduction is $67,050 ($80,000 minus $12,950). Your marginal (highest) tax rate would be 22%. But your final taxable income would be taxed like this:

This example uses 2022 tax rates and rules for single filers in the 22% tax bracket, which are likely to change in future years. It is for illustrative purposes only and should not be considered tax advice. For current tax rates and rules that apply to your specific situation, go to www.irs.gov.

Your effective tax rate

In this example, your effective (average) federal tax rate would be 13% ($10,369 divided by $80,000)—not a flat 22%.