TAXABLE INCOME: Definition, Examples & Calculations

Taxable income
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You can receive income in many ways: money, services, or some sort of property. The amount of your income, such as your social security income or employment wage, that determines what you’ll pay as tax makes up your taxable income. Seeing that your income is not only measured in terms of money, how, then, can you calculate your taxable income? The formula in this guide will help you calculate the taxable income for yourself or your business. 

Definition Of Taxable Income

Taxable income is the amount of income needed to determine the taxes owed by an individual or business. Taxable income is also known as adjusted gross income or adjusted income with fewer deductions or exemptions.

Wages and salaries are not the only sources of taxable income. Bonuses, tips, unearned income, and investment income are all examples of unearned income. Government benefits, spousal support payments, canceled debts, disability payments, strike benefits, and lottery and gambling winnings are examples of unearned income. Investment income may include interest on investments, dividend payments, and earnings from assets that appreciated and were sold during the year.

Taxable income also includes employer-provided fringe benefits, revenue from virtual currency, and services or items gained in barter.

Child support, earnings from life insurance policies, inherited money, worker’s compensation payments, compensation for accidents, welfare benefits, scholarships or grants for school, and income deposited into the earner’s retirement account up to a certain amount are all examples of nontaxable income.

Example of Taxable Income

Jenny is working on her taxes. Her wages as a corporate accountant are taxable, but her stock options are not taxable until they are exercised. Her only uncle recently died, leaving Jenny a large sum of money and a stake in his railroad company. Jenny is not required to report the inheritance as taxable income because estate taxes have already been paid. Jenny’s employer, her uncle’s railroad, and she both contribute to her 401(k) retirement plan. Jenny will also not claim this money as taxable income.

The Taxable Income Formula

The taxable income formula is used to calculate the total income taxable under the income tax. For individuals, the taxable income formula is simple and is calculated by deducting the income tax exemptions and deductions from the total income earned, while businesses calculate it by deducting all expenses and deductions from the total revenue and other income earned.

In layman’s terms, it refers to the amount of income earned by an individual or organization that may result in a tax liability. The method for taxable income for an individual is quite straightforward on the surface, and it is calculated by deducting all tax-exempt expenses and all eligible deductions from gross total income.

For an individual, we calculate the taxable income as follows:

The formula for Taxable Income = Gross Total Income – Total Exemptions – Total Deductions

For a corporation, we calculate the taxable income by deducting the cost of goods sold and operational expenses. and debt interest paid on the company’s gross sales. To get at the final income, an adjustment for a tax deduction or credit is made.

It is written thus,

The formula for Taxable Income = Gross Sales – Cost of Goods Sold – Operating Expense – Interest Expense – Tax Deduction/ Credit

A Breakdown On How To Calculate The Taxable Income 

For An Individual:

#1. Determine the individual’s gross total income first. Gross total income covers all sources of income such as wages/salaries, property rental income, capital gains from asset sales, income from other business interests, and so on.

#2. Determine the individual’s total number of exemptions. Various types of tax exemption include charities, humanitarian help, instructional resources, and so on. Depending on the reporting country, the list may differ.

#3. Then, sum the deductions related to the individual’s income. Tax deductions may include school loan interest, house loan interest, medical expenses, and so on. This list may potentially differ based on the country of reporting.

#4. Calculate the taxable income formula by subtracting total exemptions and total deductions from the individual’s gross total income, as illustrated below.

Total exemptions – total deductions = taxable earnings.

For A Corporation:

  • The sales department must confirm gross sales.
  • The accounting department then determines the cost of products sold.
  • The operating expense is then computed using data from the accounts department.
  • The interest paid is then computed based on the interest rate charged and the company’s outstanding debt.

Interest expenditure = interest rate * debt

  • Determine all of the company’s tax deductions and credits.

Finally, the taxable income equation is calculated by deducting the cost of items sold, operational expenses, and interest paid on debts from the company’s gross sales, as illustrated below.

Taxable earnings = gross sales – cost of goods sold – operating expenses – interest expense – tax deduction/credit

Is Social Security Income Taxable?

For most Americans, the social security income is taxable. That is, the vast majority of those who receive Social Security benefits pay income tax on up to 50% or even 85% of their payments because their combined income from Social Security and other sources exceeds the extremely low tax limits.

To reduce the amount of tax you pay on Social Security benefits, you can adopt one of three strategies: deposit some retirement income in Roth IRAs, remove taxable income before retiring, or purchase an annuity.

What Percentage of Your Social Security Income Is Taxable?

Since 1983, Social Security benefits have been taxed above certain income limitations. Because there have been no inflation changes to those restrictions since then, most people who get Social Security benefits and have other sources of income pay some tax on the benefits.

No taxpayer, regardless of income, gets all of their Social Security benefits taxed. The highest level provides 85% of the entire benefit. Here’s how the Internal Revenue Service (IRS) calculates how much is taxable:

The calculation begins with your adjusted gross income (AGI) from Social Security and all other sources. That may include wages, self-employed earnings, interest, dividends, required minimum distributions (RMDs) from eligible retirement funds, and other taxable income.

Then tax-free interest is added. (It is not taxed, but it is included in the calculation.)

If your total income exceeds the minimum taxable threshold, at least half of your Social Security benefits will be deemed taxable income. To calculate your net income, you must first take the standard deduction or itemize your deductions. The amount you owe is determined by where your number falls in the federal income tax tables.

Adjusted Gross Income + Nontaxable Interest + Half of Your Social Security Benefits = Combined Income

The key to lowering taxes on your Social Security payment is to reduce your taxable income when you retire, not your overall income.

Individual Income Tax Rates

If you file a federal tax return as an individual and your total gross income from all sources is as follows, your benefits will be taxed:

Between $25,000 and $34,000: You may be required to pay income tax on up to 50% of your benefits.

More than $34,000: You may be taxed on up to 85% of your benefits.

If you receive Social Security payments, the IRS publishes a worksheet that can be used to compute your total income taxes owed. If your gross income reaches $25,000 for an individual or $32,000 for a couple, you will find that your taxable income has increased by up to 50% of the amount you received from Social Security. Furthermore, if your combined income reaches $34,000 for a person or $44,000 for a couple, the taxed percentage jumps to 85% of your Social Security benefit.

Assume you were an individual taxpayer who received the typical amount of Social Security: approximately $18,000. In addition, you had $20,000 in “other” income. When you add the two, you obtain a gross revenue of almost $38,000. However, your combined income is barely $29,000. (other income plus half of your Social Security benefits). That is in the $25,000-$34,000 area for a 50% tax on your benefits. So, your taxable amount is half of the difference between that income and the $25k threshold: ($28,000 – 25,000 = $3,000; $3,000/2 = $1,500). For taxpayers with different types of income, the calculation might get more difficult.

Taxes on Married Couples

If you and your spouse have the following total income and file a joint return, your benefits will be taxable:

Between $32,000 and $44,000: You may be required to pay income tax on up to 50% of your benefits.

More than $44,000: You may be taxed on up to 85% of your benefits.

Assume you are a semi-retired couple filing jointly with a total Social Security benefit of $26,000. You also made $30,000 in “other” income. When you add the two, you obtain a gross income of $56,000. Your total Social Security income is $43,000. (other income plus half of your Social Security benefits). This combined income is between $32,000 and $44,000, which means that half the difference between the income and the threshold is calculated at 50% to determine your taxable amount: ($43,000-32,000 = $11,000; $11,000/2 = $5,500).

Categories of Taxable Income

Individuals and businesses are taxed on their whole income after deducting permitted deductions. There are four broad categories of income that are taxed:

#1. Earnings from employment

Employment income is typically defined as a person’s pay or compensation paid by their employer. It can also include any vacations, gifts, or additional perks provided by your employer as part of your work. There are minimal expenses that can be deducted from job income in general, yet there are several exceptions for salespeople.

#2. Profits from business

The law distinguishes between employment and business revenue. An individual, a partnership, or a corporation can earn business income, which includes any money earned from a profession, trade, or any other business where you anticipate making a profit. Some rental revenue is also considered company income. For instance, if the landlord provides unusual services such as laundry or housecleaning, or if the owner operates an office with workers that oversee rental properties. This form of revenue typically allows for business expenses to be deducted.

#3. Property earnings

The law also mandates taxpayers to pay tax on property income, which includes interest from investments and loans, as well as rent from investment properties. Expenses can often only be deducted from this form of revenue if they are directly related to obtaining the income. Interest on a loan used to purchase the property is a regular deduction from property income. There are also property income laws that prohibit you from moving property income to a spouse or kid solely to reduce the amount of tax you must pay.

#4. Gains in capital

Capital gains are taxed differently under the legislation. In general, if you sell capital property, such as stocks, for more than you purchased for it, the difference is termed a capital gain. If you sell something for less than you purchased it, the difference is considered a capital loss. If you make a capital gain, only half of it is taxed.

What Is Not Taxable Income?

According to the CRA, there are some payments that you do not have to disclose as part of your income and are not taxable. These are some examples:

  • Credits for GST/HST
  • Benefits from the Canada Child Tax Act and related provincial and territorial programs
  • Child support payments
  • Lottery profits
  • The majority of gifts and inheritances
  • The majority of the money paid from a life insurance policy after someone dies
  • The majority of funds received from a tax-free savings account (TFSA)
  • The majority of compensation obtained for personal injuries
  • Amounts exempt from taxation under Section 87 of the Indian Act
  • Amounts paid by Canada or an allied nation for a veteran’s disability or death as a result of service.
  • The majority of strike pay earned by a union

In Conclusion,

You have seen that not all of your income is taxable. Your taxable income includes your employment and property earnings, as well as the revenue from your business. With the guide provided in this article, you will be able to efficiently calculate your taxable income.

Taxable Income FAQs

What is a taxable income example?

The wages, salaries, and any bonuses you earn from your job are all examples of taxable income.

What is personal income of an individual?

Personal income is the total amount of money received by a country’s citizens.

What are 3 types of income tax?

Three types of income tax include wealth tax, capital gains tax, and corporate tax.

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