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Your income determines how much you owe in Federal and state income taxes. Calculating your taxable income can be a daunting process as it requires adding up income from all sources.
With the tax season just around the corner, it is important to know how to calculate taxable income. In this comprehensive guide, we will find out what taxable income is and how you can calculate it to determine the amount of taxes you owe.
So read on.
What Is Taxable Income?
Taxable income is a part of your gross income that is used to determine how much you owe in taxes each year. It is basically your adjusted gross income (AGI) minus your tax deductions.
Your taxable income includes income from all sources, including salaries, wages, freelance income, and income from a small business. It also includes tips, bonuses, income from investments, and other unearned income.
Calculating your taxable income is not as simple as adding up all the income from various sources. It is a lengthy process that must be done right so you don’t end up making any calculation errors while filing your taxes.
How to Calculate Taxable Income?
Follow the steps below to calculate your taxable income:
Step 1: Find Out Your Filing Status
The first step to calculate your taxable income involves finding out your filing status. Married people can choose to file jointly or separately. Whereas unmarried people can file their taxes as a single filer or as head of household if they have any dependents.
Step 2: Prepare All the Documents
Once you have determined your filing status, prepare all the documents to account for all your and your spouse’s and dependents’ income sources. The sum of all these income sources will be your gross income.
To calculate your gross income, you will need Form W-2, Form 1099-NEC (for non-employee compensation), Form 1099-INT, and Form 1099-MISC (for amounts greater than $600).
Step 3: Find Out Your Adjusted Gross Income (AGI)
Next, calculate your Adjusted Gross Income (AGI). Your AGI is the amount you get after subtracting certain adjustments from your gross income, such as your education expenses. These adjustments reduce your income before any tax deductions.
Step 4: Calculate the Tax Deductions
Next, calculate your standard or itemized tax deductions. The standard tax deductions for the tax year 2023 are $13,850 for individual tax filers, $20,800 for heads of households, and $27,700 for married people filing jointly.
If you opt for itemized deductions, you will need to find out the paid local and state taxes from your W-2 form, property taxes and mortgage interest paid from Form 1098, charitable donations, unreimbursed medical bills, and education expenses.
If you are an owner of a partnership, sole proprietorship, trust, estate, or an S corporation, you can qualify for a qualified business income (QBI) deduction.
With this deduction, you can deduct up to 20% of QBI, qualified publicly traded partnership (PTP) income, and real estate investment trust (REIT).
Step 5: Subtract All the Tax Deductions
Finally, to calculate your taxable income, subtract all the eligible tax deductions from your AGI.
More About Taxable Income
Taxable income includes earned income, unearned income, interest income, dividends, and any earnings from appreciated assets that were sold during the current tax year.
Unearned income can include government benefits, lottery payments, canceled debts, and strike benefits.
When filing taxes, you need to subtract your business expenses and other deductions to find out your taxable income. You cannot treat your revenue directly as taxable income.
Types of Taxable Income
Taxable income has various sources. Some of the most common types of taxable income include:
1. Employee Compensation
The income received in the form of wages, salaries, tips, fees, and bonuses from your employer is called employee compensation. It is reported on your W-2 form which is mailed to you by your employer.
2. Business and Investments Income
Income earned from certain business and investment activities is considered taxable income and must be declared. This includes rental income, income you receive from any business you may own or operate, and income from successful investments.
3. Freelance Income
Income received from working as an independent contractor or freelancer is known as freelance income. Freelance income is also taxable and must be reported to the authorities.
4. Partnership Income
Income received from partnership entities is passed through to each partner. Even though the IRS does not tax partnership members, they are obliged to declare any and all pass-throughs on their annual tax returns.
5. Capital Gains Income
Income received from capital gains is also taxable. This includes the profits you receive from selling your investments, such as bonds, stocks, or real estate. It is a part of your overall AGI.
6. Other Sources
Some other sources of taxable income include income from S Corporations, bartering, royalties, and digital currencies.
Conclusion
Your taxable income is the sum of all your income from various sources, minus the adjustments and tax deductions. It constitutes a part of your gross income.
Now that you know how to calculate taxable income, it will be easier for you to file your tax returns more accurately. Knowing how to calculate your taxable income accurately can help you avoid any mistakes and complications. Good luck!
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