The recent Tax Cuts and Jobs Act saw the corporate income tax rate declining from 35% to 21%. Taxation of income has significant benefits on the American economy. However, it is essential to note that not all income is taxable.
Income can be in the form of services, property, or money. The IRS has outlined the different taxable and non-taxable income succinctly. Understanding these distinctions in income taxes is essential.
If you want to know the difference between taxable and non-taxable income, you’re in the right place. This comprehensive guide will outline everything you need to know about taxable and non-taxable income.
What are the Differences Between Taxable and Non-Taxable Income?
According to the Internal Revenue Code, taxable income refers to the gross income after deductions.
The gross income is the money received from different sources. That means you not only pay taxes from your wages but also sources such as investments.
Taxable income is quite broad, considering that the IRS is not interested in how you get your money. Interestingly, you ought to pay taxes even from a business venture deemed illegal.
Conversely, there are other types of incomes that the IRS considers non-taxable. The agency won’t tax the clearly outlined non-taxable income, so you shouldn’t mind including it in your tax returns.
Understanding the non-taxable and taxable income is one of the most crucial things to know in taxation. When you also familiarize yourself with the changes to look out for when filing taxes, you’ll find the process easier.
Whether you file taxes as an individual or as a business, it would help to know some types of taxable and non-taxable income.
Taxable Income
Failure to file your taxes on time can cost you serious fines. Every taxpayer needs to know the types of taxable income. Here is an outline of the different types of taxable income.
1. Employee Compensation
You need to include everything you earn from offering services.
The compensations include regular wages, salaries, tips, and commissions. Your employer needs to give you Form W-2, Tax, and Wage Statement, which show the amount received after offering your services.
You’re also mandated to file taxes even on income generated from your hobby. When you earn a particular amount say from playing musical instruments in an exhibition, you ought to deduct the expenses and file the tax as required.
2. Investment and Business Income
If you’re self-employed, you are liable for taxation through the business income. If you rent out personal equipment or property, you need to report the income and expenses. You should be clear on whether the rental activity is for-profit or business.
The continuity of such a rental activity is considered as a business. As such, you will have to pay taxes as per the provision of Business Expenses.
3. Fringe Benefits
When you render services, you might be a recipient of fringe benefits.
Whatever you receive as a fringe benefit is taxable, whether or not you enjoy the offerings. Some of these taxable perks include paid gym membership, financial counseling fees, holiday gifts, company car for personal use, dependent care, or life insurance over a particular amount.
Note that fringe benefits are not only for employees in a given company. A business owner might decide to provide fringe benefits to independent contractors, directors, or partners.
If you’ve received such benefits, they should be part of the taxation.
4. Royalties
When you receive royalties in the form of copyrights, patents, and mineral and gas properties, you need to file the income for taxation.
Get Form 1040 and report on Schedule E. For other forms of self-employment, you declare your expenses and income on Schedule C.
Other miscellaneous taxable income includes bartering, where you include the actual market value of service or property you receive during the process of bartering. When you exchange or sell other virtual currencies, be ready for the resultant tax liability.
Getting audited is one of the constant fear for most people.
There are several ways to reduce the chances of being audited. Other than getting the numbers right, be familiar with the deductions and exemptions.
More importantly, consider filing your taxes at the right time and with all honesty. Besides, filing your taxes electronically reduces the possibility of errors, which leads to most cases of auditing.
Non-Taxable Income
There are a variety of categories of non-taxable income. Despite the income you receive being non-taxable, it should reflect in the file return. Here are some of the non-taxable incomes that you need to know.
1. Gifts
Gifts are probably one of the most common types of non-taxable income.
If you receive any gift, you’re not liable for taxation. The giver of the award is the one who pays the tax.
While individuals can gift each other without paying any taxes, employers can only give their workers non-taxable gifts of not more than $25. It is important to note that bonuses are not gifts.
2. Financial Aid and Scholarship
If an employer provides any educational assistance to a worker, the money is non-taxable and should not be included in the employee Form W-2. However, there is an annual limit of up to $5,250.
For this kind of money to be non-taxable, the student has to use it as tuition fees, textbooks, or other course materials as using it for any other purpose attracts tax.
3. Disability Wages
A permanently or temporarily disabled employee is entitled to disability pay, which falls under non-taxable income.
The types of disability payments that are not liable for taxation include worker’s compensation, private disability insurance, and supplemental insurance. Nonetheless, the money is taxable if the employer funds an insurance policy.
4. Child Care
The payments that foster parents receive to take care of children in homes are tax-free. Payments for child support after a divorce are also not taxable. In essence, most welfare benefits fall under the category of non-taxable income.
5. Inheritances
There is no inheritance tax unless you inherit an asset that brings an income such as rental cars or buildings. However, if the deceased had unfinished tax obligations, they might be attached to assets.
It would be prudent to liaise with the will executor to know if the deceased gave directions on tax obligations.
Knowledge of Taxable and Non-Taxable Income Is Valuable When Filing Returns
Failure to file your taxes on time exposes you to a range of punitive measures such as fines and penalties. Once you know the taxable and non-taxable income, it will be easier to file your taxes. If the process seems quite complicated, you can always consult professionals in the field.
Call us today for all your taxation needs. We offer personal tax consultations and a range of other tax services for businesses and individuals.
