The Guide to Taxable Income versus Nontaxable Income: Are your income items taxable?

In a previous post, I detailed the individual taxable income formula. I described the major components in the calculation. Additionally, I provided general examples for each component. The first step in determining your individuals taxable income amount is to calculate gross income. Below I will provide a more detailed guide to taxable income versus nontaxable income. The guide should help you determine which income items to include in your gross income total. Lets begin!

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By searching in the U.S. tax code, you will discover that the tax code defines gross income as all income from whatever source derived, unless specifically excluded. Well, that is not very helpful. Because of the ambiguous language, I thought I could help taxpayers by creating a guide to taxable income items and nontaxable income items.

Taxable Income Items

The following income items are taxable. Therefore, you should include the taxable income items listed below in your gross income. By failing to report taxable income items in gross income, you will under-report your tax liability, which may result in fines and/or penalties.

Compensation

Gross income includes compensation for services. You will receive compensation for services in a variety of ways. The following forms of compensation are taxable income items to include in gross income:

• Money
• Include in gross income when received, credited, or available to you for services
• This includes: salaries, wages, cash bonuses, commissions, tips, etc. 
• Property
• Include the FMV of all property received as compensation in gross income
• Cancelled debts
• Include in gross income the amount of debts cancelled as a result of service
• Special rules apply to mortgage debt cancellations
• Bargain purchases
• A bargain purchase is a property sale for below market value between employer and employee
• Include in gross income the difference between FMV and selling price
• Partnership guaranteed payments
• Taxable fringe benefits (most fringe benefits are nontaxable)

Interest Income - taxable

The following interest income types are taxable.

• Bond interest - federal bonds, industrial development bonds, corporate bonds
• Installment sale interest
• Tax refund interest - paid by government if late on tax refund

Dividend Income

A dividend is a distribution of property by a corporation to a stockholder. The dividend can be in the form of cash or property. I detail the general dividend rules below.

• Cash dividend - amount received
• Property dividend - FMV

It is important to note that dividends are fully taxable for individuals. However, qualified dividends are subject to preferential rates, ranging from 0% to 20% based on income levels. 

For a more detailed tax accounting analysis relating to dividend income, please follow the link below.

Link: Dividend Income: How is dividend income taxed?

Divorce Payments - Taxable

Divorce agreements result in several forms of divorce related payments. The different types of payments have different tax rules. Additionally, TCJA recently changed the tax rules relating to alimony payments. The application of the change is dependent upon the date of your divorce agreement execution. The following divorce payments are taxable to the recipient. 

• Alimony
• Include in gross income alimony payments received for a divorced agreement executed before 12/31/18

Due to the complexity of the rules relating to divorce payments, please consult a tax adviser about the special rules and tax laws relating to divorce payments.

Gains on Property Sales

The difference between the amount realized and the adjusted basis of the property is a taxable gain. Property gains include gains on stock, securities, personal property, and more. Include the gain in gross income. Capital gains are subject to preferential rates.

IRA Income

Distributions from a traditional IRA are fully taxable.

Rental Income

You report net rental income on the your Form 1040; therefore, net rental income is taxable. Special rules apply.

Unemployment income

You include in gross income the full amount received for unemployment income. Unemployment income is fully taxable.

Prizes & Awards

You must include prizes and awards in gross income at fair value.

Gambling Winnings

You must include all gambling winnings in gross income. It is important to note that you do not report gambling winnings net of tax. You should report your gross gambling winnings in gross income.

Nontaxable Income Items

The following items are nontaxable. Therefore, you should not include the nontaxable items listed below in your gross income. By reporting nontaxable items in gross income, you will over-report your tax liability, which will cause you to overpay taxes.

Fringe Benefits - nontaxable

Your employer will provide you with added benefits. In general, fringe benefits are nontaxable. However, exceptions exist for benefits, and so, it is important to know the tax laws relating to the fringe benefits you receive.

• Life insurance
• Do not include the value of life insurance premiums paid on your behalf by the employer
• You may exclude from gross income life insurance premiums for up to $50,000 (any excess should be included in gross income)
• Health insurance
• The health insurance premiums paid on your behalf by your employer should not be included in gross income
• Special rules apply if your employer pays you directly relating to health insurance
• Travel, lodging, & meals
• The value of travel, lodging, and meals related to your employment paid by the employer is not taxable
• Qualified employee discounts
• Merchandise discounts, services, parking ($265 per month)
• Qualified pension, profit-sharing, and stock bonuses
• Employer payments to the stated plans are not taxable income at the time of contribution

Interest Income - nontaxable

The following interest types are not taxable.

• State and local government bond interest - municipal bond interest
• Bond interest from U.S. possessions - Puerto Rice, Guam
• Series EE savings bond interest - restrictions and requirements apply

Divorce payments - nontaxable

Divorce agreements result in several forms of divorce related payments. The different types of payments have different tax rules. Additionally, TCJA recently changed the tax rules relating to alimony payments. The application of the change is dependent upon the date of your divorce agreement execution. The following divorce payments are nontaxable to the recipient.

• Alimony
• Do not include in gross income alimony payments received for a divorced agreement executed after 12/31/18
• Child support
• Do not include in gross income any amounts designated as support for a minor child
• Property settlements
• Do not include in gross income a lump-sum payment or property settlement from your ex-spouse

IRA Income

Distributions from a Roth IRA are not taxable if the amount is withdrawn without penalty. 

Gifts

Gifts are not taxable to the recipient. Do not include the value of the gift in your gross income.

Inheritances

Inheritances are not taxable to the recipient. Do not include the value of the inheritance in your gross income.

Workers' Compensation

Workers' compensation received under the worker's compensation act is not taxable to the recipient.

In conclusion

The post covers a significant amount of information relating to taxable income versus nontaxable income. I hope you gained tax knowledge about your specific income items. Below, I placed all the information from above into a chart. Study the chart to learn if your income items are taxable or nontaxable.

As always, please share with others to help them learn about taxable income items versus nontaxable income items. Additionally, comment below if you have any questions relating to if your income items are taxable!