What Is Taxable Income According to the IRS?

Taxable income is the portion of a person’s earnings subject to federal income tax and serves as the basis for calculating the tax an individual owes the Internal Revenue Service (IRS) each year. This figure is not the total money earned, but the result of a multi-step calculation defined by tax law. The journey to finding your taxable income is a process of refinement, starting with all your income and systematically subtracting specific deductions and adjustments. This final number determines which tax brackets apply and the total tax liability for the year.

Components of Gross Income

The starting point for any tax calculation is determining gross income. The IRS defines this broadly under Internal Revenue Code Section 61 as all income from whatever source derived, unless it is specifically exempt by law. This comprehensive definition means that nearly every form of inflow, whether in money, property, or services, must be accounted for.

Taxable Income Sources

For most individuals, the largest component of gross income is earned income from employment. Gross income also includes earnings from self-employment, freelance work, and unearned income. Common sources that must be included are:

• Wages, salaries, tips, commissions, and bonuses
• Earnings from self-employment or freelance work
• Interest earned from bank accounts
• Dividends from stock investments
• Distributions from retirement accounts like a 401(k) or traditional IRA
• Rental income from property
• Royalties and unemployment compensation
• Capital gains from the sale of assets, such as stocks or real estate

Non-Taxable Income

While the definition of gross income is expansive, tax law explicitly excludes certain types of income from taxation. These items are not included in the gross income calculation. Common examples of non-taxable income include:

• Gifts and inheritances
• Proceeds from a life insurance policy paid out due to the death of the insured
• Certain scholarships and fellowship grants used for tuition and fees
• Child support payments
• Some welfare benefits
• Compensatory damages awarded for physical injury or sickness

Calculating Adjusted Gross Income (AGI)

After establishing total gross income, the next step is to calculate Adjusted Gross Income (AGI). AGI is derived by subtracting specific “above-the-line” deductions from your gross income. These adjustments are available to all eligible taxpayers, regardless of whether they choose to itemize deductions later. The resulting AGI is used to determine eligibility for various tax credits and other deductions.

Some of the most common above-the-line deductions include:

• Contributions to a traditional Individual Retirement Arrangement (IRA)
• The student loan interest deduction, up to a maximum of $2,500 per year
• Contributions to a Health Savings Account (HSA)
• One-half of self-employment taxes for those who are self-employed
• Alimony payments for divorce agreements finalized before 2019

Arriving at Taxable Income from AGI

The final calculation to determine taxable income involves subtracting “below-the-line” deductions from your AGI. This step presents a choice for every taxpayer: whether to take the standard deduction or to itemize deductions. The goal is to select the option that results in a larger deduction, thereby lowering taxable income more effectively.

The standard deduction is a fixed dollar amount that the IRS allows you to subtract from your AGI, with the amount varying based on your filing status, age, and whether you or your spouse are blind. For the 2024 tax year, the standard deduction for a single individual is $14,600, while for married couples filing jointly it is $29,200. These amounts are indexed for inflation and adjusted annually.

Alternatively, a taxpayer can choose to itemize deductions if their total eligible expenses exceed their standard deduction amount. Common itemized deductions include:

• State and local taxes (SALT), capped at $10,000 per household per year
• Mortgage interest on a primary residence
• Charitable contributions made to qualified organizations
• Medical and dental expenses that exceed 7.5% of the taxpayer’s AGI

After subtracting either the standard or itemized deduction, one more potential deduction is the Qualified Business Income (QBI) deduction. Introduced by the Tax Cuts and Jobs Act of 2017, this allows eligible owners of pass-through businesses, such as sole proprietorships, partnerships, and S corporations, to deduct up to 20% of their qualified business income. The final result is your taxable income.

The Role of Taxable Income in Your Tax Calculation

Once the final taxable income is determined, it is used to calculate the actual amount of tax owed. The United States employs a progressive tax system with marginal tax rates, meaning different portions of your income are taxed at different rates. These rates are organized into tax brackets, and your taxable income will fall into one or more of them.

For example, for the 2024 tax year, a single filer’s income is taxed at different rates as it crosses certain thresholds. The first portion of their income is taxed at 10%, the next portion at 12%, then 22%, and so on. If a single filer has $60,000 in taxable income, not all of it is taxed at the 22% rate; only the portion of income that falls within that specific bracket is taxed at 22%, while the earlier portions are taxed at the lower rates.

After the initial tax liability is calculated based on the tax brackets, the final step is the application of tax credits. Unlike deductions, which reduce your taxable income, tax credits directly reduce your tax bill on a dollar-for-dollar basis. Common credits include the Child Tax Credit, the American Opportunity Tax Credit for education expenses, and the Earned Income Tax Credit for low- to moderate-income workers. The application of these credits results in the final tax amount due or the refund owed.