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What is Considered Taxable and Non-Cash Taxable Income?
In its simplest definition, "income" is money (cash) received and often earned through employment or investing. With that said, when it comes to the IRS definition of "income", they have a much broader interpretation. Not only is the government interested in money received as payment but also other forms of compensation.
As such, it is the taxpayer's responsibility to pay tax on the fair market value of either the goods or services received. Understanding the difference between taxable and nontaxable income can be confusing during tax season. Most wages, salaries, tips, and other forms of income are taxable.
Nontaxable income tends to come in the form of benefits, rebates, and inheritances. For example, child support income, welfare benefits, health care benefits, and gifts tend to be forms of nontaxable income. If you have received a rebate from the purchase of a car or other product, the rebate may be a form of nontaxable income. Rebates and cash back bonuses aren't taxable if it is considered a reduction to the original purchase price, in other words a discount. However, in certain situations rebates are considered to be gifts and in this case, they are taxable.
Taxable income also applies to all gifting, bequests and inheritances of either cash or property. The first $14,000 (per recipient) of a cash gift does not incur any tax at the present time.
Income tax also applies to company perks or benefits. Often, companies offer benefits to attract the best employees (company cars, complementary meals, shuttling, lodging, etc). Any perk given to an employee is considered by the government income and is taxable.
As for more traditional taxable income such as wages, salaries and tips, most often this is recorded on the taxpayers W-2(s) and will be entered on line 7 of a 1040. Outside of income reported on a W-2, there is also income reported on a 1099-div and 1099-int. This can include among other things interest, dividends, refunds, credits, alimony, capital gains, retirement/pension/annuity distributions, unemployment and social security benefits.
The Internal Revenue Service (IRS) asks that all taxpayers calculate investment income separately from employment income. Investment income is defined as any money made from interest, capital gains, dividends or the sale of assets, such as real estate or securities.
To calculate investment income, all you have to do is find the sum of the following:
- Profit from selling stocks, bonds and mutual funds
- Capital gains from mutual funds
- Profit from the sale of real estate that does not serve as a primary residence
- Profit from the sale of private companies or S corporations
- Taxpayers may also be eligible to defer taxes on the interest of some investments as well. Instead of paying taxes on the interest as they earn it, they pay when the investment reaches maturity which can be beneficial to many taxpayers. For more on this see Taxes on Interest.
Foreign income is money that is earned in other countries. This income should be declared alongside all income earned in the United States on your 1040 form. Foreign income may be eligible for the Foreign Tax Credit. With this credit, some of your foreign income may not be taxed if it is properly taxed by the country where it was earned. This credit cannot be used when you itemize your foreign income. You may be able to exclude some foreign income with special exclusion rules based on how much you earned, where you earned it and how you earned it.
A 1099-misc tax form is designed for independent contractors as opposed to regular employees. If you work as an independent contractor and earn more than $600 from a given payer during a tax year, then you should receive a 1099 tax form from them If you receive this form and fail to file it correctly, you can be penalized by the IRS.
This penalty will vary based on how much money you earned during the tax year. The IRS looks at your overall tax liability, which refers to the amount of taxable income you receive in a year. Therefore, when you fail to file your 1099 accurately, you can be penalized up to 20 percent of your underpayment. That means if you fail to report $1,000 on your 1099, you may be penalized up to $200.
On the other hand, payers can also be penalized for not using a 1099-misc correctly. If a business does not issue a 1099-misc for an independent contractor who earns at least $600 throughout the year, then you can be fined anywhere from $30 to $100 per form with a maximum penalty of $500,000 per year. Even if a contractor does not provide a 1099-misc form, they are still responsible for reporting any income over $600 to the IRS.
Taxable income covers that which has been mentioned above and much more. When it comes to filing any benefit, cash equivalent or other, is considered to be taxable and the responsibility of the filer to report it.
Ways to Help Lower Your Taxable Income
A taxpayer's income does not always depict the taxes which they wind up paying. There are a number of ways taxpayers may reduce their taxable income and lower their tax bill. Here are some of those:
1. IRA Contributions
One of the most effective ways to lower your taxable income is to contribute to an IRA or 401k. If you're employed and under age 50, you can deduct up to $5,500 to reduce your taxable income; the amount goes up to $6,500 if you're over age 50. Married couples filing jointly can double these amounts. Employer-sponsored IRAs sometimes have restrictions on the amounts you can deduct, so speak with your plan administrator as you prepare to file your taxes.
2. Fund a Health Savings Account
If you have a qualifying health plan you may be able to fund a Health Savings Account (HSA). HSA's allow you to pay for out-of-pocket medical expenses using pre-tax dollars. For a detailed explanation of how HSA's can reduce a taxpayer's taxable income click here.
3. Fund a Medical Flex Plan
Flex plans also allow the use of pre-tax dollars for certain medical expenses. Up to $2,500 can be added annually to flex accounts, and these funds will directly reduce a taxpayer's reported income.
4. Use Pre-Tax Dollars to Pay Certain Expenses
Some employers offer accounts to employees that are funded with pre-tax wages in order to pay for expenses like child care. These accounts offer families an effective way to reduce their reported income.
In addition to reducing ones taxable income, taxpayers can also reduce their tax bill by offsetting some income with deductions. Here are a few of the most common deductible expenses:
1. Interest Payments
Taxpayers are permitted to deduct certain interest payments they make. This includes interest on their mortgage, equity lines of credit, student loans, investment properties and business loans.
2. Charitable Donations
Non-cash donations to charitable organizations may be tax deductible. If you donated to nonprofits such as the Salvation Army or Goodwill, you may be able to use the amount to reduce your tax bill. Remember to ask the organizations accepting your donation for a receipt. You can also donate stock/bond securities owned for more than a year to a charity and deduct the full value as documented on the day the gift was made.
3. Investment Losses
If you took a loss in an investment account, such as a stock account, you can deduct that loss. The IRS allows taxpayers to deduct up to $3,000 annually for capital losses. If your loss was more than $3,000, you can carry the remaining balance of the loss into a future year.
4. Job-Related Expenses
If an employer doesn't cover direct job-related expenses (such as work supplies or travel) and the expenses exceed 2% of your income, you may be able to deduct them. If you plan to deduct non-reimbursed work expenses, be sure to save all of your receipts.
5. Real Estate Taxes
You can deduct the property taxes on your primary and secondary residence on your taxes. You may also be able to deduct property taxes on investment properties such as rentals. Paying real estate taxes before the end of the year means you can deduct them on the current year's taxes as opposed to waiting until the following year. Note, in certain situations with filers in higher income brackets, this can trigger the alternative minimum tax. See more on the alternative minimum tax.