People need to pay their taxes so that the government can keep the country running. Your tax money pays for the military and police, education service providers, healthcare, and the maintenance of roads, bridges, sewers, and more.
What are Taxable and Non-Taxable Income?
The amount of tax you need to pay depends on your income. However, keep in mind that there are two types of income: taxable and non-taxable.
Taxable Income
Income can come in the form of money, property, or services you receive in the tax year. There are two basic types of income which are earned and unearned income.
The money you receive from an employer in exchange for your job, as well as the money you make working for yourself, is considered earned income. Interest and dividends, Social Security payments, alimony, and other unearned income are examples of unearned income.
You must first calculate your adjusted gross income, or AGI, in order to determine your taxable income. Tour AGI is effectively all of your taxable earned income minus any income adjustments you’re qualified for before you start itemizing deductions.
Non-Taxable Income
Most wages paid to employees are taxable, but there are cases when an individual does not have any taxes withheld (income, federal, state, etc.)– which makes their wages non-taxable.
There is a very short list of non-taxable income and other tax-exempt income. You would want to talk to a tax professional to confirm if you are in compliance with the IRS to avoid a penalty.
The Effects of Your Taxable Income on the Tax You Own
During tax season, most people are mostly concerned about their taxable income. Here are some of the things you may want to know about it:
Does taxable income affect how much tax I need to pay?
As mentioned previously, your tax is based on how much income you earn. It means that your taxable income determines your tax bracket. Your tax bracket influences your income tax rate which in turn affects the amount of tax your need to pay.
Note that Federal Income Tax is progressive– meaning, your income tax rates will increase as you earn more income.
The lower your taxable income is, the lower your corresponding tax rate would be– this means that your tax liability will most likely be lower as well.
So yes, your taxable income does affect the amount of tax you need to pay.
Will your taxable income affect your tax refund?
As an employee, you will notice that a portion of your paycheck goes to your taxes. And if you are self-employed, you need to pay your quarterly taxes throughout the year.
It is possible for you to pay more than you owe– and in that case, the government needs to return your overpayment. The more tax you overpaid, the bigger your tax refund. Since your income tax rate is based on your taxable income– it does play a part when it comes to the computation of the tax you owe and it can affect your tax refund as well.
How to Lower Your Taxable Income?
You need to pay your taxes based on your taxable income. However, there are ways you can lower your taxable income without earning less:
Invest in your retirement contribution.
Your contributions to 401(k)s and traditional IRAs may be deductible from your tax. Generally, the government does not tax the income you’re allowed to contribute to these retirement plans. On top of that, you don’t get taxed on their earnings as well. But do keep in mind that you need to pay taxes when you take the money out of these accounts.
Make charitable donations.
Charitable contributions are deductible from your tax. But you need to make sure that the organization is a registered charity under Section 501 (c)(3).
Defer your Holiday Bonus
If you do not want to owe additional taxes on your holiday bonus in the current tax year, you can check if your employer would agree to give it to you in the next year.
Evaluate and clean up your investment accounts.
If you have some investments, check and evaluate them. See if you have lost money in any of them. You can sell and claim those losses and offset any capital gains you report.
The Final Takeaway
Understanding taxable and non-taxable income can help you determine how much tax you need to pay. It allows you to file your tax more accurately. However, it can still be a confusing process for anyone. Working with a tax professional or an accounting expert can always lift the stress and pressure from your shoulders by lifting your worries or concerns regarding errors and mistakes on your tax computation.