Taxes
General Tax Basics
10 Min Read | Jan 5, 2024
By Ramsey Solutions
By Ramsey Solutions
Did you know a portion of your income is tax-free? That’s right. Hands off, Uncle Sam!
We’ll get to why some income is tax-free (cough, cough—tax deductions), but the rest of your pay is known as taxable income because it’s . . . well, taxable.
Knowing how much of your income is taxableandhow it’s going to be taxed is important because it’ll help you understand what you’ll owe on Tax Day (April 18 this year).
So, how do you know what income is taxable and what isn’t? And how exactly do you calculate your taxable income? Let’s dig a little deeper and find out.
What Earnings Count As Taxable Income?
What do getting your paycheck, bartering and winning the lottery have in common?
They all come with taxable income.
What?Yep. The truth is, the IRS taxes a lot of stuff, not just your salary or hourly wages—like most folks assume. If your income falls under any of the categories below, you have to report it on your federal tax return.
Income you earn:Whether you worked for someone or you were self-employed, your earned income isalwaystaxable. This includes wages, salaries, commission, freelance earnings, holiday bonuses and tips.
Winnings:After years of dreaming,you finally heard the announcer say, “Come on down. You’re the next contestant onThe Price Is Right!” And when you won a new washer and dryer, you jumped up and down like a kid waiting in line for ice cream. Then you got the bad news: You have to paytaxeson that. Yep. It’s true. You must report anything you win from gambling or betting—even prizes you win on a game show or in a contest.
Money or property you gain:So, maybe you didn’tworkfor a portion of your income. Maybe you earned money from your investments or you own a rental property. Is that income taxable?Yes.In particular, the IRS considers all of the following to be taxable income:
- Canceled or forgiven debt
- Profits from the sale of stock or other investments
- Interest or dividends from investments
- Proceeds from the sale of real estate
- Rents
- Royalties from copyrights and patents
- Stock options
- Unemployment compensation
- Union strike benefits
- Gains from virtual currency (like Bitcoin)1
A few of these types of income are consideredcapital gains. This includes money you earn from the sale of an asset such as a share of stock or a piece of real estate. Capital gains are divided into short term (assets held less than a year) and long term (assets held for more than a year). Short-term capital gains are added to your taxable income and taxed at the same rate as your income, but long-term capital gains are separate and taxed at a capital gains rate, which is typically lower than the rate of your income tax bracket.
Real estate sales also have their own set of rules. For example, let’s say you sell the house you’ve lived in as your primary residence. As long as you’ve lived there full time for two of the previous five years, you don’t pay any taxes on your profit up to $250,000 (or $500,000 for a married couple)1. Now, if you bought a house, fixed it up, and flipped it three months later for a profit, your profit is considered taxable income.
Exchanges or bartered services:This one surprises people. Let’s say you’re a mechanic and your best friend—a carpenter—builds a deck on your house. In exchange, you fix the transmission on his truck. According to the IRS, both of you must declare the value of the other’s service as income.
Don’t settle for tax software with hidden fees or agendas. Use one that’s on your side—Ramsey SmartTax.Fringes:Afringeis a benefit your company gives to you. It can be anything from a paid gym membership to a Christmas bonus. Like prize winnings, you will be taxed on fringes.
What Doesn’t Count As Taxable Income?
Yeah, we know what you’re thinking. That’s alotof taxable income. But believe it or not, the IRS doesn’t taxeverything. Generally, here’s what the IRS usually considersnontaxable income:
- Accident and personal injury rewards
- Cash rebates
- Child support
- Alimony
- Federal income tax refund (duh!)
- Foster care payments
- Inheritances and money gifts (up to a certain amount)
- Life insurance payouts
- Scholarships or fellowship grants
- Veterans benefits
- Welfare benefits2
One quick warning before we move on. Some of thesecanbe taxable under certain circ*mstances.
For example, let’s say you win a scholarship and you use it for tuition. Well, in that case, you wouldn’t have to worry about taxes. But if you use that money for room and board or you don’t use that money for school at all and you buy a car instead, itwouldbe taxable.
Our rule of thumb for deciding what’s nontaxable: Don’t guess. If there’s uncertainty, contact atax professionalwho can look at the type of income and your particular situation.
How Do Tax Deductions Affect Your Taxable Income?
Earlier, we told you a portion of your incomeisn’ttaxed. Well, let’s get down to it. Youcanreduce your taxable income. How?
Withtax deductions.
What Is a Tax Deduction?
Tax deductionsreduce your taxable income which, in turn, reduces your tax bill. For example, let’s say Tom earns $62,000 in 2023 as a teacher. He takes thestandard deduction, so he can subtract $13,850 from his annual income.3That means the IRS can only tax $48,150 of his income.
Wait. Standard deduction?
Right, if you’re not sure about deductions, we can back up a minute. When it comes to filing taxes, you can take astandard deduction($13,850 for single filers in 2023 or $27,700 for married couples filing jointly). Or you canitemizedeductions from a list made by the IRS that includes things like charitable giving, mortgage interest and property taxes.
The thing to remember here is this: You can’t doboth. You can take the standard deductionoryou can itemize. So how do you choose? Pick the one that saves you more money! If you’re not sure which one to choose, definitely contact atax pro.
How Can I Lower My Taxable Income?
If taxpayers were puppies, this is when their tails would start wagging.Lower my taxable income?Yes! Finally. We’re at the part when we talk about how you can save money on your taxes.
1. Take advantage of tax deductions.
Yes, itemizing is a pain, and the standard deduction usually cuts your tax bill the most. But if it means saving more money, take the extra time (and aspirin) it takes to itemize.
2. Use adjustments to income if you can.
Adjustments to income are the tax filer’s secret weapon. They work like itemized deductions and the more you qualify for, the more you can take off your taxable income. But here’s the thing: They’renotitemized deductions. That means even if you take the standard deduction, you can still use them.
Okay, so how do you know if you qualify for adjustments to income? You do if you answeryesto any of these questions:
- Did you pay student loan interest?
- Did you make contributions to a traditional HSA or IRA?
- Did you receive income from self-employment?
- Did you teach K–12?
- Did you pay a penalty for withdrawing from a savings account?
You can find more adjustments to income on theIRS website.If you qualify for any of these adjustments, you’ll need to fill out Schedule 1 on Form 1040 to subtract those amounts from your taxable income.
3. Contribute more to a traditional 401(k).
You don’t pay taxes on money you invest in a traditional 401(k). For example, let’s say you make $53,000 and you invested $3,000 in your 401(k) at work. Standard deductions and itemizing aside, you can take $3,000 off your taxable income to make it $50,000.
So, if your employer gives you the option to invest in a traditional 401(k), feel free to contribute to your 401(k) at least up to the employer match (if offered). In 2023, you can put up to $22,500 in your 401(k)—and if you’re 50 or older, you can contribute an extra $7,500.4
Now, we want to be clear on something:We don’t want you to investjustto reduce your taxable income.You should wait to invest for retirement until you’ve finishedBaby Step 1(save $1,000 for a started emergency fund), Baby Step 2 (pay off all debt using the debt snowball), and Baby Step 3 (save 3–6 months of expenses in a fully funded emergency fund).
Saving for retirement starts at Baby Step 4. Yes, it’s great that contributing to a traditional 401(k) can help reduce your tax bill. And if you have one, go for it. But there are other investing options out there—like a Roth IRA—that can help you grow your actualinvestmenttax-free. So, once you meet the employer match in your 401(k), start investing in a Roth IRA.
What Tax Bracket Is My Income In?
Okay, once you’ve calculated your taxable income, the next step is to determine yourtax bracket. Think of tax brackets as an income range that corresponds to a tax rate. If that sounds like a mouthful, here’s what the 2023tax brackets look like.
2023 Federal Income Tax Brackets and Tax Rates
Tax Rate | Single Filer | Married, Filing Jointly | Married, Filing Separately | Head of Household |
10% | $0–11,000 | $0–22,000 | $0–11,000 | $0–15,700 |
12% | $11,000–44,725 | $22,000–89,450 | $11,000–44,725 | $15,700–59,850 |
22% | $44,725–95,375 | $89,450–190,750 | $44,725–95,375 | $59,850–95,350 |
24% | $95,375–182,100 | $190,750–364,200 | $95,375–182,100 | $95,350–182,100 |
32% | $182,100–231,250 | $364,200–462,500 | $182,100–231,250 | $182,100–231,250 |
35% | $231,250–578,125 | $462,500–693,750 | $231,250–346,875 | $231,250–578,100 |
37% | Over $578,125 | Over $693,750 | Over $346,875 | Over $578,1005 |
And for 2024, those tax brackets will remain the same, but tax rates will be adjusted for inflation:
2024 Federal Income Tax Brackets and Tax Rates
Tax Rate | Single Filer | Married, Filing Jointly | Married, Filing Separately | Head of Household |
10% | $0–11,600 | $0–23,200 | $0–11,600 | $0–16,550 |
12% | $11,600–47,150 | $23,200–94,300 | $11,600–47,150 | $16,550–63,100 |
22% | $47,150–100,525 | $94,300–201,050 | $47,150–100,525 | $63,100–100,500 |
24% | $100,525–191,950 | $201,050–383,900 | $100,525–191,950 | $100,500–191,950 |
32% | $191,950–243,725 | $383,900–487,450 | $191,950–243,725 | $191,950–243,700 |
35% | $243,725–609,350 | $487,450–731,200 | $243,725–365,600 | $243,700–609,350 |
37% | Over $609,350 | Over $731,200 | Over $365,600 | Over $609,3506 |
The U.S. tax system isprogressive(are you having flashbacks to your U.S. government class yet?). That means the higher your taxable income, the more taxes you pay.
But here’s the thing, folks: You don’t just fall into one income range (unless your income is in the first range, then you do). Your income is spreadacrossthem.
For example, let’s say you’re singleand after taking the standard deduction ($13,850), you have a taxable income of $60,000 in 2023. Here’s what that would look like:
First tax bracket:$11,000 x 10% = $1,100
Second tax bracket:$33,725 x 12% = $4,047
Third tax bracket:$15,275 x 22% = $3,361
Total income tax:$8,508
And that’s the magic of the American tax system!
File Your Taxes With Confidence
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About the author
Ramsey Solutions
Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.
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