Generally, when the question of whether an item of income is taxable, the answer is normally yes. Income is taxable unless it is specifically exempt from tax by law, and some income that is nontaxable must be reported on an income tax return (e.g., tax-exempt interest on a municipal bond).
When is income taxable
Income is taxable to you when it is made available to you without restriction even if you don’t have possession of it.
For example, if you receive a check that was mailed to you with plenty of time to receive before the end of the year, then it is generally taxable to you in the year mailed even if you do not deposit the check until after the end of the year. If a check was mailed to you on December 31 of the year it could not possibly be received by the end of the year, and this check will taxable in the next year (the year received).
Some business owners might receive a payment for future services and such payment is generally taxable for cash basis business owners. Business owners who use the accrual method of accounting and receive a payment for future services may defer this income (report in the next year) if it is for services to be performed before the end of the next year.
Items considered taxable income
***The list below of items considered taxable income is not exhaustive. Remember, all income is taxable unless precluded from taxation by law.
Salaries and Wages – Taxable payments received as an employee include salaries, wages, commissions, tips, bonuses, gifts received from an employer beyond a de-minimis amount.
Dividends, Interest, Capital Gains – Income from stocks, bonds, mutual funds, and other investment interests are generally taxable income. Please note that some types of portfolio income qualify for special tax rates.
Rental Income – Income received from rent of personal or real property is considered taxable income. Expenses allocable to such property are generally deductible; although some limits apply for property used both as a rental and for personal purposes.
Business Income – Business income is taxable, so if you operate a small business, the income is taxable and reduced by deductible expenses (care should be taken to note that hobby businesses have special rules that need to be considered).
Passthrough Income – If you have investments in a partnership or an S-corporation then your share of the income from the activity is taxable. Also note, that in some instances losses from these activities may be limited by basis limitations or the passive activity rules
Royalty Income – Royalty income from natural resources, intellectual resources (art, photography), patents, or copyrights is taxable. Allocable expenses may be deducted.
Social Security Benefits – Only a portion of Social Security benefits are taxed and some taxpayers may avoid taxation of Social Security benefits in their entirety. Social Security income benefits are taxable when a base amount of income exceeds a certain level based on filing status.
The easiest way to think about the base amount is to take one-half of your Social Security benefit and add this to all your other income. The base amount for married couples filing jointly is $32,000 and $25,000 for Single, head of household, and qualifying widower. If your income exceeds this base amount, then you will likely report some taxable benefits.
Temporary or one-time jobs – In the gig economy, many people take side jobs as an independent contractor. The income from these one time or temporary jobs is taxable and may be subject to self-employment taxes if the activity is regular and consistent. A one-time side job might be excluded under the self-employment tax depending on facts and circumstances but will still be subject to income tax.
Unemployment Compensation – payments received from a state unemployment compensation fund are taxable in the year received.
Bartering Income – Bartering is the exchange of goods and/or services for other goods and/or services. Suppose a hair stylist exchanges four haircuts valued at $20 each for a massage valued at $80 with his client who is a massage therapist. Each party must report the fair market value of the services received as taxable income. In this example, each party would report $80 as taxable income.
Retirement Income – Distributions from retirement plans such as Traditional IRA’s, 401(k) plans, pensions, and the earnings portion of non-qualified annuities are generally subject to tax. A taxpayer with basis in a Traditional IRA will have a portion of each distribution considered to be a return of basis and not taxable.
Taxable Refunds of State and Local Taxes – Refunds of state local tax that were deducted on Schedule A as an itemized deduction are taxable to the extent of the tax benefit allowed.
Prizes and Awards – These are generally reported on Form W-2 if received by an employee and on Form 1099MISC – Box 3 Other Income for non-employees. The FMV of noncash prizes and awards is taxable.
Virtual Currency – Virtual Currency (e.g., Bitcoin) has tax implications. Very generally, a business that receives payment for goods and services is required to report the FMV of the virtual currency received as sales/fee revenue. A taxpayer who uses virtual currency as payment for goods and services may recognize a gain or loss on the difference in the cost basis of the virtual currency used and the FMV at the time of the transaction. (Caution: This is a new and evolving area in tax compliance, and taxpayers who own virtual currency should seek professional guidance for tax reporting compliance).
Canceled Debt – In most cases, if a debt you owe is canceled or forgiven, other than as a gift or bequest, the amount canceled is included in your income. There are exceptions for debt discharged in a Title 11 bankruptcy case or in the event you are insolvent. This is another area where legal assistance is important.
Items generally not considered taxable income
***The items listed below is not exhaustive and may not apply to every situation.
Municipal Bond Interest – Interest on debt from state or local governments (and subdivisions) is generally not subject to federal taxes. This interest may be taxable for state purposes. The interest must be reported on the Form 1040 and while not taxable, it does impact taxable Social Security benefits. Finally, the sale of a municipal obligation may generate a capital gain or loss.
Gifts received or inheritances – In general, the recipient of a gift or inheritance does not recognize tax on the receipt of the assets. However, income earned on assets inherited or received by gift will generally be taxable. For example, if you inherit a rental property, the receipt of the property is not taxable; however, the rent received from the property will be taxable.
Life Insurance Proceeds – Proceeds from life insurance paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price (e.g., life settlement transactions). In some cases, an insurer may include a small amount of interest in life insurance proceeds (possibly as a result of a claim delay) and the amount of interest received with the proceeds would be taxable.
Child Support Payments – Child support payments are not deductible by the payer and are not taxable to the recipient.
Damages for Physical Injury or Sickness – Damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical illness are not taxable. This exclusion does not generally apply to punitive damages. Please note that this is a complex area of tax law and legal representation is advised.
Working Condition Fringe Benefits – These are generally benefits provided to employees so they are able to effectively perform their jobs. For example, if you work for a counseling practice and your employer provides you with a subscription to a trade publication, this is not taxable to you. Other examples include employer provided continuing education, job tools, and employer provided cell phone service if such is qualified.
Disability Insurance Payments – The taxation of disability benefits depends on who pays the premium. If you pay the disability premiums with after tax dollars whether on an employer sponsored plan or an individual policy, then the benefits are tax free.
If the employer pays any part of the premium the taxability is split. For example, suppose your employer pays 25% of your disability premium as part of a group benefit, and you pay the remainder with after tax dollars. The disability benefit would be taxed at 25% (the percentage the employer paid).
If you pay any part of your premium is paid through a cafeteria plan or a medical reimbursement plan, then the part of the premium paid through this benefit will be taxable.
“Qualified” Roth IRA Withdrawals – Qualified distributions are tax free if the withdrawal meets the following requirements: (1) It is made after the 5 year period beginning with the first year a contribution was made to the account (five year rule), (2) The payment of the distribution is made on or after the date you reach age 59.5, or made because you were disabled, or made to a beneficiary or an estate after your death, or meets the requirements of the first time homeowner exceptions ($10,000 lifetime limit).
While the above is not a comprehensive list of taxable or nontaxable items, the list includes the most common items that impact a broad range of taxpayers. The tax law is filled with exceptions and special circumstances that are beyond the level of this post.
If you have any questions about your personal circumstances, please feel free to contact us in Lubbock at (806) 470-9609.