Taxable income versus gross income: an overview
Gross income includes all income you receive that is not explicitly exempt from tax under the Internal Revenue Code (IRC). Taxable income is the part of your gross income that is actually taxable. Deductions are subtracted from gross income to arrive at your taxable income amount.
Key points to remember
- Gross income is all income from all sources that is not specifically exempt from tax under the Internal Revenue Code.
- Taxable income begins with gross income and then some allowable deductions are subtracted to arrive at the amount of income that you are actually taxed on.
- Tax brackets and marginal tax rates are based on taxable income, not gross income.
Taxable income is a layman’s term that refers to your Adjusted Gross Income (AGI) less any itemized deductions you are entitled to claim or your standard deduction. Your AGI is the result of certain âover-the-lineâ income adjustments, such as contributions to an Individual Qualified Retirement Account (IRA), interest on student loans, and certain contributions made to savings accounts. -health.
Taxpayers can then either take the standard deduction for their filing status or itemize the deductible expenses they paid during the year. You are not allowed to itemize the deductions and claim the standard deduction. The result is your taxable income.
Claiming the standard deduction often reduces an individual’s taxable income more than itemizing it, as the Tax Cuts and Jobs Act (TCJA) has nearly doubled these deductions from what they were before 2018. .
The standard deduction for 2021 is $ 25,100, an increase of $ 300 from 2020, for married couples filing jointly; $ 12,550, an increase of $ 150, for individual returns for single taxpayers and married individuals filing separately; and $ 18,800, an increase of $ 150, for heads of households.
For tax year 2022, these deductions will increase slightly:
- For single taxpayers and married people filing separately, the standard deduction is $ 12,950, up $ 400 from the previous year.
- The standard deduction for married people filing jointly is $ 25,900, up from $ 800.
- For heads of households, the standard deduction is $ 19,400, up from $ 600.
A taxpayer would need a considerably large amount of medical bills, charitable contributions, mortgage interest, and other qualifying itemized deductions to exceed these standard deduction amounts.
Gross income is the starting point from which the Internal Revenue Service (IRS) calculates an individual’s tax liability. This is all of your income from all sources before any allowable deductions are made. This includes both income earned on wages, salaries, tips, and self-employment, and unearned income, such as dividends and interest earned on investments, royalties, and gambling winnings.
Certain withdrawals from retirement accounts, such as minimum required distributions (RMD), as well as income from disability insurance, are included in the calculation of gross income.
Gross business income is not the same as the gross income of the self-employed, business owners and businesses. Rather, it is the total revenue from the business less eligible business expenses, that is, gross profit. The gross income of business owners is called net business income.
Some people confuse their gross income with their salary. Wage income often makes up the bulk of an individual’s gross income, but gross income also includes unearned income.
Gross income, however, can incorporate a lot more, essentially anything that is not explicitly designated by the IRS as exempt from tax. Tax-exempt income includes child support, most support payments, compensatory damages for bodily injury, veterans benefits, social assistance, workers’ compensation, and labor compensation. additional security income. These sources of income are not included in your gross income because they are not taxable.
Example of taxable income versus gross income
Joe Taxpayer earns $ 50,000 a year from his work, and he has an additional $ 10,000 in unearned income from investments. His gross income is $ 60,000.
For the 2020 tax year, Joe claimed an adjustment above the income line for $ 3,000 of contributions he made to a qualifying retirement account. He then claimed the standard deduction of $ 12,400 for his single file status. His taxable income is $ 44,600. Although he has an aggregate gross income of $ 60,000, he will only pay tax on the lower amount.