Taxable Income vs. Gross Income: An Overview
Gross income includes all income you receive that isn't explicitly exempt from taxation under the Internal Revenue Code (IRC). Taxable income is the portion of your gross income that's actually subject to taxation. Allowable deductions are subtracted from gross income to arrive at your taxable income.
Key Takeaways
- Gross income is all income from all sources that isn't specifically tax-exempt under the Internal Revenue Code.
- Taxable income starts with gross income, then certain allowable deductions are subtracted to arrive at the amount of income you're actually taxed on.
- Tax brackets and marginal tax rates are based on taxable income, not gross income.
Taxable Income
Taxable income is a layman's term that refers to your adjusted gross income (AGI) minus any itemized deductions you're entitled to claim or the standard deduction according to your tax filing status (e.g., single, married filing jointly, or head of household). Your AGI is the result of taking certain "above-the-line" adjustments to income, such as contributions to a qualifying individual retirement account (IRA), student loan interest, and some contributions made to health savings accounts.
Taxpayers can then take either the standard deduction for their filing status or itemize the deductible expenses they paid during the year. (You're not permitted to both itemize deductions and claim the standard deduction.) When you subtract either your standard deduction or your itemized deductions from your AGI, the result is your taxable income.
Claiming the standard deduction often reduces an individual's taxable income more than itemizing because the Tax Cuts and Jobs Act (TCJA) virtually doubled these deductions from what they were prior to 2018.
Thestandard deductionfor 2023 is $27,700 for married couples filing joint returns; $13,850 for single taxpayers’ individual returns and married individuals filing separately; and $20,800, for heads of households.
For the 2024 tax year, these deductions will increase slightly:
- For single taxpayers and married individuals filing separately, the standard deduction rises to $14,600, up $750 from the prior year.
- The standard deduction for married people filing jointly is $29,200, up $1,500
- For heads of households, the standard deduction is $21,900, up $1,100.
A taxpayer would need a significant amount of medical costs, charitable contributions, mortgage interest, and other qualifying itemized deductions to surpass these standard deduction amounts.
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Gross Income
Gross income is the starting point from which the Internal Revenue Service (IRS) calculates an individual's tax liability. It's all your income from all sources before allowable deductions are made. This includes both earned income from wages, salary, tips, and self-employment as well as unearned income, such as dividends and interest earned on investments, rent, royalties, and gambling winnings.
Some withdrawals from retirement accounts, such as required minimum distributions (RMDs), as well as disability insurance income, are included in the calculation of gross income.
Gross business income is not the same as gross revenue for self-employed individuals, business owners, and businesses. Rather, it's the total revenuesobtained from the business minus allowable business expenses—in other words, gross profit. Gross income for business owners is referred to as net business income.
Gross income, however, can incorporate much more—basically anything that's not explicitly designated by the IRS as being tax-exempt. Tax-exempt income includes child support payments, most alimony payments, compensatory damages for physical injury, veterans' benefits, welfare, workers' compensation, and Supplemental Security income. These sources of income are not included in your gross income because they're not taxable.
Some people confuse their gross income with their wages. Wage earnings often do make up the bulk of an individual's gross income, but gross income includes unearned income, too.
Taxable Income vs. Gross Income Example
Joe Taxpayer earns $50,000 annually from his job, and he has an additional $10,000 in unearned income from investments. His gross income is $60,000.
For the 2023 tax year, Joe claimed an above-the-line adjustment to income for $3,000 in contributions he made to a qualifying retirement account. He then claimed the $13,850 standard deduction for his single filing status. Therefore, his taxable income is $43,150. While he had $60,000 in overall gross income, he will only pay taxes on the lower amount.
Is Taxable Income the Same as Earned Income?
Taxable income is not the same as earned income. Earned income is any income you receive from a job or self-employment. It can include wages, salary, tips, commissions or bonuses. By contrast, taxable income is your gross income minus any above-the-line adjustments to income that you're allowed (for example, for qualifying retirement account contributions or student loan interest) minus either the standard deduction or itemized deductions you're entitled to claim.
How Can I Reduce My Taxable Income?
There are a number of ways to reduce your taxable income, some of which are only useful if you itemize your deductions. Here are a few ideas:
- Contribute the maximum to a 401(k) at work. In 2024, the limit is $23,000, but if you are 50 or older, you can contribute an extra $7,500.
- Consider opening an individual retirement account (IRA). Be aware of the IRS rules on IRAs, as you may not be able to deduct your contribution under certain circ*mstances.
- Give to charity.
- Contribute to a high-deductible health savings account.
Are Social Security Benefits Taxed?
Your benefits may be taxable according to this calculation: If the total of half of your Social Security benefits plus all your other income (including tax-exempt interest) is greater than the base amount for your filing status. For those who are married filing jointly, the base amount is $32,000. For those who are single, head of household, or married filing separately, it is $25,000.
The Bottom Line
Taxable income and gross income are not the same thing, but it's easy to get confused about the difference. Fortunately, not all of your gross income—which includes both earned (wages, salary, tips, bonuses, et al) and unearned (interest, dividends, rents, royalties, et al) income—is taxable, thanks to any deductions and credits that you can legitimately claim. To keep more of your money, it also makes sense to take advantage of as many deductions and credits as you are legally entitled to.
