For example, the following types of income are all taxable for federal income tax purposes:
Business and self-employment income Dividends Gambling winnings Most interest income Pass-through income Rental income Royalties Tips Unemployment compensation Wages, salaries, bonuses, and commissions
Keep in mind that just because you received a taxable item of income during the year does not necessarily mean you have to pay taxes on it. This is because you are permitted to subtract relevant adjustments and deductions from the amount of your income subject to tax when calculating your tax liability on your tax return, such as Form 1040 for federal income tax purposes. Generally speaking, for federal income tax purposes, all income a taxpayer receives is taxable income unless the tax law of the Internal Revenue Code specifically exempts it from tax. Therefore, all income earned by United States citizens and residents is taxable income unless the Internal Revenue Code specifically states that a particular item of income is not taxable. Other jurisdictions imposing income taxes—such as state governments—have their own tax laws that determine whether a portion of income is taxable or not. This means some of a taxpayer’s income may be taxable income for federal income tax purposes, and nontaxable income for state income tax purposes, and vice versa. For example, while unemployment compensation is generally taxable for federal income tax purposes, some states, such as California, exclude unemployment compensation for state income tax purposes. On the other hand, while municipal bond interest income is generally nontaxable for federal income tax purposes, only interest on municipal bonds issued by California localities is nontaxable for California income tax purposes. Interest on municipal bonds issued by non-California localities is taxable in California.
Taxable Income vs. Nontaxable Income
While taxable income is income that is subject to tax, nontaxable income is income that is not subject to tax because the relevant tax law states it is not taxable. For federal income tax purposes, the following kinds of income are generally nontaxable for federal income tax purposes:
Child supportDividends on life insuranceGiftsInheritancesLife insurance proceedsInterest on municipal bondsSupplemental Security Income (SSI)
Sometimes, whether an item of income is taxable or nontaxable will depend on other components of a taxpayer’s tax return. For example, a taxpayer’s Social Security benefits received may be taxable if one-half of the amount of their benefits, plus all their other taxable income, plus their tax-exempt interest, is greater than a certain amount based on their filing status.
