Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Taxable Income

What it is:

Taxable income is any type of compensation that triggers a tax liability.

How it works (Example):

There are two kinds of taxable income: Earned income (salary, wages, tips, bonuses, commissions, etc.) and unearned income (dividends, interest, rents, alimony, winnings, royalties, etc.).

For example, let's assume that Jane works for Company XYZ. Her salary is $75,000 per year. At the end of the year, Company XYZ will send a W-2 form to the IRS reporting that it paid Jane $75,000 that year. When Jane fills out a Form 1040 to calculate her federal income tax owed, the $75,000 in earned income, less any deductions, credits, or exemptions, will be used to calculate her taxable income.

In a second example, let's assume that Jane has a big tomato garden in the backyard. Bill, her next door neighbor, is a hairdresser. Jane and Bill have an arrangement whereby Bill comes over to cut Jane's hair in return for two crates of tomatoes. This is bartering, and even though no cash changes hands, the IRS requires Jane to report the value of the services she receives as taxable income and it requires Bill to report the value of the tomatoes as taxable income.

Why it Matters:

It is important to note that income is more than just the wages you earn at your job. Generally, if you receive compensation in any form, it's likely to qualify as taxable income. Some unusual examples include prize winnings, debt in your name that is forgiven by a creditor, gifts, payments made for jury duty, strike benefits, unemployment benefits, and even money you embezzle.

Also note that you may be entitled to assorted tax deductions, credits and exemptions that enable you to decrease the amount of your income that is subject to taxation.

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