Taxable Income: What It Is and How to Calculate It
Knowing what income is taxable can help you minimize your overall tax liability.
Your taxable income is the portion of your income subject to federal tax, and it’s important for several reasons.
To start, your taxable income amount determines your tax bracket and marginal tax rate. Understanding your taxable income can help you determine how much tax you'll owe, if any, and potentially help in lowering your tax bill.
The most common taxable income for many people is earned income, or money earned through wages, bonuses and tips. (Speaking of tips: The recently enacted Trump administration’s so-called “One Big Beautiful Bill” provides a deduction for up to $25,000 of reported tip income for eligible workers starting this tax year, 2025.)
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For more information, see Kiplinger’s report: No Tax on Tips Bill Approved.
The IRS requires that you report all taxable income and file an accurate tax return. Here’s what else you need to know.
What is taxable income?
Taxable income is the portion of your gross income that's subject to federal tax. Taxable income and gross income differ for several reasons.
- Not all income is taxable.
- Tax deductions and credits can lower the amount of your income that is subject to tax.
- Your federal taxable income is essentially your federal adjusted gross income (AGI) minus any tax deductions you claim.
Types of taxable income
There are many types of taxable income that must be reported to the IRS on your federal tax return.
- Earned income: These are wages, salaries, commissions, bonuses and tips earned through employment.
- Self-employment income: If you're self-employed, any money earned from operating your own business, being an independent contractor, gig work or freelance jobs, must be reported on your income tax return.
- Disability payments: Some Social Security payments, such as disability benefits, are subject to taxation as they're considered earned income.
- Capital gains: If you earn a profit from selling real estate, stocks or other assets, it's considered a capital gain and is subject to taxes.
- Unemployment income: Unemployment benefits are considered taxable income and must be reported to the IRS. Some states don’t tax unemployment benefits.
Other common types of taxable income include royalties, interest and dividend income, canceled debt (with some exceptions), and lottery winnings.
Note: Federal taxable income isn't always the same as state taxable income, largely because not all states tax the above types of income, and some states don’t have income tax.
What is non-taxable income?
Not all income is taxed at the federal level. For example, life insurance proceeds you receive as a beneficiary and employer-provided health insurance aren't included in gross income.
Gifts aren’t taxable as long as you don’t exceed the federal gift tax exclusion for 2025, which is $19,000 ($38,000 per married couple).
These are just a couple of examples. Other types of income are not subject to tax.
Calculate taxable income in three steps
Determining your federal taxable income can be done in three simple steps.
Step 1: Take all sources of income received during the year and subtract certain "above the line" deductions (adjustments from gross income which you don't have to itemize to claim). The "line" in above-the-line refers to Line 11 on Form 1040, where AGI is listed.
Some above-the-line deductions include the following.
- Contributions to certain retirement plans, such as 401(k)s and IRAs, and SEP and SIMPLE plans
- Student loan interest paid
- Certain business expenses
- Penalties on certain early savings or CD withdrawals
- Contributions made to a health savings account (HSA)
- Deductible self-employment taxes
- Self-employment costs for health insurance premiums
- Educator expenses
- Alimony paid (divorced before 2019)
- Active-duty military moving expenses (unreimbursed)
Step 2: Once above-the-line deductions are subtracted from your income, consider your filing status and determine whether to claim the standard deduction or itemize deductions.
Learn more: What's the Standard Deduction?
Step 3: Once you determine your taxable income (AGI minus all applicable deductions), that and your filing status determine your federal income tax bracket and marginal tax rate.
Note: Luckily, your tax preparer, if you use one, will calculate your AGI and taxable income for you. If you use a tax preparation product or do your taxes online, the software performs the calculations.
How to lower your taxable income
The best way to lower your taxable income is to take advantage of all the tax deductions and credits you qualify for.
Common but often overlooked tax deductions include charitable contributions and donations, student loan interest paid, and in some cases, unreimbursed medical expenses.
However, not everyone is eligible for every tax deduction or tax credit. A trusted tax professional can help ensure you don’t miss out on tax breaks for which you qualify. A professional might also be able to formulate a tax strategy that aligns with your financial goals.
Related Content
- How to Lower Your Tax Bill Next Year
- New ‘No Tax on Tips’ Bill Approved for 2025: What to Know
- How Bonuses Are Taxed
- Federal Income Tax Brackets and Rates for 2025
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