Taxable Income: What It Is and How to Calculate It

Twenty dollar bills on an IRS 1040 tax form.

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 will 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.)

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 is subject to federal tax. Taxable income and gross income differ for several reasons.

• First, not all income is taxable.
• Additionally, tax deductions and credits can lower the amount of your income that is subject to tax.
• So, 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 different types of taxable income that must be reported to the IRS on your federal tax return. Here are some.

1. Earned income: These are wages, salaries, commissions, bonuses, and tips earned through employment.
2. Self-employment income: If you are 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.
3. Disability payments: Some Social Security payments, such as disability benefits, are subject to taxation as they are considered earned income.
4. Capital gains: If you earn a profit from selling real estate, stocks, or other assets, it is considered a capital gain and is subject to taxes.
5. 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. That’s 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 are not 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. (Above-the-line deductions are adjustments from gross income. And you don't have to itemize to claim them.) 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 you qualify for. A professional may also be able to formulate a tax strategy that aligns with your financial goals.