There are many sources of income. Most types of income are taxable, but it might surprise you to find that some types of income aren’t taxed.
Here are the most common sources of taxable income:
Wages, salaries, and tips. Wages and salaries are the most common type of income. By law, your employer must send you a Form W-2 that shows how much you were paid. Besides your salary, the amount reported also includes any commissions, bonuses, vacation pay, sick pay, or severance pay that you received. Your employer also reports other amounts, such as Medicare and Social Security taxes withheld.
Severance pay. Severance pay is a cash payment you receive based upon the length of time you were employed by a company. If you receive severance pay upon termination of employment, the amount you receive is taxable.
Tips. Any tips that you receive are considered taxable income. To learn more, see Tip Income.
Extra cash. Are you doing a little work on the side to make some extra money? If so, any money that you make is considered self-employment income and should be reported on Schedule C. If you make more than $400 from your side job, you must also file a Schedule SE and pay Social Security and Medicare taxes on the income. Use the Interview to enter your self-employment income and TaxCut will make sure that your income is reported correctly.
Alimony received. If you receive alimony as a result of a divorce decree or separation agreement, the payments you receive are fully taxable.
Alimony paid — reporting requirements. If you paid alimony during the year, you can deduct it even if you don’t itemize deductions — the IRS considers it an "adjustment to income." You must include your ex-spouse’s name and Social Security number on your tax return. If you’re claiming the deduction, the IRS wants to make sure someone is reporting the same amount as income. There’s a $50 fine if you fail to include your ex-spouse’s Social Security number. Use the Interview to report your alimony payments and TaxCut will make sure that your payments are reported correctly.
Unemployment benefits. Unemployment benefits are fully taxable. To learn more, see Unemployment Income.
Other types of taxable income include:
Jury duty pay. Any jury duty payments that you receive are taxable. However, you can deduct any part of the payment that you give to your employer in exchange for continuing your salary.
Pension and annuity payments. Normally, pension and annuity payments are taxed, although a portion of the payment may be tax free. For example, after-tax contributions to an annuity are considered tax free when withdrawn. Go through the IRA, Pension Income section of the Interview to calculate the taxable amount.
Awards. If you receive an award from your employer as a result of your job performance, the award is usually taxable. If the award is an all-expense-paid trip or some other type of goods or services, you must include its fair market value in your income.
However, gifts of property that you receive in recognition of your length of service or because of a safety achievement, such as a gold watch, are tax free. The amount that is tax free, though, is limited to your employer’s cost, and the value of the gift can’t exceed $1,600.
Barter. The fair market value of any property or services that you receive (or provide) in exchange for work done is considered taxable income. If you’re a member of a barter exchange, you should receive a Form 1099-B that shows the fair market value of all property and services you traded during the year.
Disability payments. If your employer pays the premiums for your disability insurance, then any disability payments you receive are generally fully taxable. If you pay the premiums, however, the payments you receive are tax free. Veterans’ disability benefits and workers’ compensation are also tax free. Report disability payments in the IRA, Pension Income section of the Interview.
Gambling winnings. Gambling winnings are fully taxable. This includes everything from large lottery and sweepstakes payouts to money you win playing bingo and items you win in a raffle. To learn more, see Gambling Winnings.
Prizes. All prizes are taxable — it doesn’t matter whether you win the Nobel Prize or win a car on a game show. If you win a prize, you must include the value of the prize in your income.
Check the list below for the most common types of tax-free income. For a complete list, see IRS Publication 525: Taxable and Nontaxable Income.
Auto rebates. Since the IRS doesn’t consider rebates to be income, you don’t have to pay tax on them.
Car-pool receipts. If you drive a car pool to and from work, you don’t need to report payments you receive from passengers to the IRS. These payments are considered reimbursement for your expenses, not income, and are tax free.
Child support payments. Child support payments are tax free and shouldn’t be reported on your return. For more information, see Alimony and Child Support.
Casualty insurance proceeds. If you’re reimbursed for a loss, such as a car accident or house fire, you generally don’t have to report the income on your return. However, you should include the reimbursement payment when figuring any gain or loss from the casualty or theft because some of the payment might be taxable. We'll help you through this.
Combat pay. All pay for enlisted personnel and non-commissioned officers while serving in a combat zone is tax free. If you’re a commissioned officer, however, the amount that you can exclude is limited to the highest rate of enlisted pay (plus any imminent danger / hostile fire pay you receive) for each month that you serve in a combat zone. For more information, see IRS Publication 3: Armed Forces’ Tax Guide.
Damages. Compensation that you receive for damages for a physical injury or sickness is usually tax free. In addition, compensation that you receive for emotional distress suffered as a result of the injury or sickness is also tax free. However, if you receive compensation for lost wages or profits, or punitive damages, the income is taxable.
Dividends on a life insurance policy. Since premiums are usually paid with after-tax dollars, any dividends that you receive are considered to be an overpayment of your premium. These are usually tax free. If the total of the dividends that you receive exceeds the total of the premiums that you paid, then the excess amount is taxable.
Coverdell education savings accounts. Withdrawals from these accounts are tax free as long as the money is used to pay for qualified education expenses, such as tuition, books, and fees, at an eligible educational institution. To learn more, see Education Savings Accounts.
Gifts. A gift is tax free to the recipient. To qualify, the gift must be given out of true kindness. A promotional gift given away by a bank as an incentive to open a new account doesn’t qualify as a gift. Its value would be considered taxable income.
If federal gift tax is owed on the gift, the tax is owed by the giver of the gift.
Health and accident insurance benefits. If you’re reimbursed for medical expenses that you paid out-of-pocket, the money you receive isn’t taxable. Compensation that you receive for the permanent loss of the use of part of the body or permanent disfigurement isn’t taxable either.
Health savings accounts. When you withdraw money from a health savings account to pay qualifying medical expenses, the withdrawal is tax free.
Inheritances. Any money or property you inherit is tax free. However, if you inherit a traditional IRA or company retirement benefits, you must pay tax on the income just as the deceased would have had to do.
When you sell inherited property, your basis is usually the property's fair market value on the day the person who bequeathed it to you died. You need to know the basis of the property so that you can figure the amount of capital gain or loss for your taxes.
Life insurance. Life insurance proceeds paid to you because of the death of a loved one aren’t taxable. However, if you decide to have the proceeds paid to you in installments over a number of years, the interest earned on that account is taxable income.
If your spouse died before October 23, 1986, and you’re receiving installment payments, you can exclude up to $1,000 a year in interest included in the installments. You can continue to take the exclusion even if you remarry.
Municipal bond interest. If you receive interest on bonds issued by state and local governments, the interest is usually tax free. If you’re subject to the alternative minimum tax and you receive interest on some "private purpose" bonds, the interest earned is taxable income.
Public safety officer survivor benefits. If you’re a survivor of a public safety officer killed in the line of duty, you might be able to exclude certain amounts you receive from income, such as an annuity that you receive under a government plan. Public safety officers include law enforcement officers, firefighters, chaplains, and rescue squad and ambulance crew members. For more information, see IRS Publication 559: Survivors, Executors, and Administrators.
Profits on the sale of a home. If you owned and lived in your home for 2 of the 5 years before you sold it, you can exclude up to $500,000 of profit from taxable income on a joint return. (If you’re single, the exclusion limit is $250,000.) However, if you have a home office or rent out part of your home, depreciation allowed after May 6, 1997, will be taxed at 25% on the profit made.
Roth IRA withdrawals. One of the major benefits of a Roth IRA is that withdrawals can be tax free. Withdrawals up to the amount of your contributions are always tax free. In addition, once you turn 59½, any withdrawals you make are tax free if the account has been open for at least 5 years (counting the year that you made your first contribution). To learn more, see Individual Retirement Accounts.
Scholarships and fellowship grants. If you use scholarship or grant money for tuition and related expenses (such as books, supplies, and equipment required for a course), the money is tax free. However, if any of the money is used to pay room and board, that portion of the money is considered taxable income.
Social Security. Depending upon your income, Social Security benefits may be entirely tax free or partly taxable. For most recipients, Social Security benefits are completely tax free. However, if you file a single return and your income exceeds $25,000 ($32,000 for joint filers), up to 85% of your Social Security benefits can be taxed.
When figuring your income, make sure to include tax-free interest income and 50% of your Social Security benefits. Use the Interview and TaxCut will figure out how much of your Social Security benefit is taxable.
State and local tax refunds. Generally, if you claimed the state or local income tax that you paid as an itemized deduction on your previous year’s return, then your state or local income tax refund is taxable. However, even if you did itemize, part of the refund could be tax free. To learn more, see State and Local Income Tax Refunds.
Veterans’ benefits. Veterans Affairs disability payments are tax free.
Workers’ compensation. If you receive compensation for an injury you suffered on the job, that compensation is tax free.