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Taxable vs. Nontaxable Income: What’s the Difference?

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Taxable vs. Nontaxable Income: What’s the Difference? - TaxAct Blog

If you receive money, goods or services, you might have to pay tax on the value of what you receive as taxable income.

That’s true for money you earn, as well as, any interest and dividends you receive on your investments. Unless the Internal Revenue Service (IRS) specifically outlines a type of income as nontaxable…you pay tax on it.

Here’s a quick breakdown of various forms of income you may receive, and whether they’re generally taxable or nontaxable.

Earned income

Taxable: You pay tax on wages, salaries and tips. Bonuses are also taxable and included on your Form W-2. Cash paid “under the table” is taxable, even if you do not receive a Form 1099-MISC to report it.

Jury duty pay may not amount to much, but it’s still taxable unless you turn it over to your employer in exchange for continuing to receive salary pay.

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

Nontaxable: Your employer can provide benefits that you don’t have to include in taxable income.

For example, the cost of life insurance up to $50,000, qualified adoption assistance, child and dependent care benefits and contributions you make to health insurance may not be subject to taxes.

Income given or paid to you by other people

Taxable: Alimony payments received are considered taxable income. Additionally any court awards you receive for lost pay and punitive and business damages are subject to taxes.

Nontaxable: Gifts, regardless of size, are not generally taxable to the recipient. The donor can gift up to $14,000 without being taxed as well. Combat pay and child support are examples of nontaxable income.

Damages you receive for physical injury, sickness or emotional distress and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable.

However, you must include in your income the portion of the settlement that is for medical expenses you deducted in any prior year to the extent the deductions provided a tax benefit.

Retirement and disability income

Taxable: You pay tax on retirement and disability income if you did not already pay tax on contributions, or if you did not pay the premiums to receive income.

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

Up to 85 percent of your Social Security income may be taxable if your income is above certain levels.

Nontaxable: You don’t pay tax on disability income if you paid the premiums yourself, or if the benefits are connected to government service. You also don’t pay tax on Roth-type retirement plans, which you contributed to using after-tax dollars.

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

Investment income

Taxable: Interest and dividends are taxable income, unless specifically exempt.

Nontaxable: Municipal bonds are nontaxable on your federal return. Any dividends that are a return of capital are also not subject to taxes, as opposed to dividends that are a share of profits.

Income from the sale of assets

Taxable: Your gain from the sale of an asset is generally taxable. Your gain is generally your basis (the amount you paid for an asset), minus the amount you received when you sold it.

For example, if you buy a stock for $100 and sell it for $200 (after selling expenses), you have a $100 gain ($200 – 100 = $100). You also pay tax on your gain from selling business property, stocks and bonds, investment real estate, collectibles and personal items that have gone up in value.

You may need to adjust your basis for other items. For example, you reduce your basis for any depreciation you take on a business asset. You increase your basis for additional expenses, such as major improvements.

Nontaxable: One of the best breaks in the tax code is when you sell your home, you may not have to pay tax on the first $250,000 of gain ($500,000 if filing jointly).

You must own and live in the home for two of the last five years to have this gain be nontaxable, and you must not have taken this exclusion in the two-year period before the sale of the home.

If you receive money from a garage sale, you generally do not need to report the sales because most garage sale items are sold for less than their original cost.

Other income

Taxable: Gambling winnings are taxable. However, you can deduct gambling losses if you itemize your deductions. Unemployment benefits are fully taxable.

Nontaxable: If you receive an inheritance, it is not taxable. The person’s estate pays estate and inheritance taxes before it gives money to any heirs. But, if there is interest or other income generated from inherited cash it is taxable.

Have you ever received income you assumed was nontaxable, such as unemployment benefits, and discovered later that you had to include it in taxable income?

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About Sally Herigstad

Sally Herigstad is a certified public accountant and personal finance columnist and author of Help! I Can't Pay My Bills, Surviving a Financial Crisis (St. Martin's Griffin). She writes regularly at CreditCards.com, Bankrate.com, Interest.com, RedPlum, and MSN Money. She is an experienced speaker and a member of Toastmasters International. Follow Sally on Twitter.