What’s Taxable Income?

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by Elle Martinez · 6 comments

You’ll see many sites advising you to lower your taxable income. What exactly does that mean? Which part of your income is taxable?

Taxable Income and You

Quite simply how much you owe on taxes is based on your taxable income and your filing status. When you dig deeper your taxable income also affected by how you earned it. Income earned from your job or business is taxed differently than your investments.

Wages and Salary

Most people are familiar with income earned through their employment. At the beginning of every year you should receive a W-2 form from your employer recording all of your wages from the previous year. It’ll also include your federal and state withholding as well as Social Security and Medicare taxes paid.

Self-Employment Earnings

As a business owner it’s your responsibility to make sure you keep meticulous records. You’re not subject to payroll taxes, instead you still are responsible for your self employment taxes. Paying your estimated taxes regularly helps you to avoid penalties from the IRS.

If you work as an independent contractor your income will be reported on 1099 forms (provided it’s $600 or more).

Interest Income

While interest income is not taxed for Social Security and Medicare, you can be taxed at the normal income tax rates. There are some bonds issued by state and local governments that don’t get taxed at the federal level. However they can be taxed by the state and municipality respectively.

Dividends

Dividend income is not subject to Social Security taxes, but they are considered taxable income. If dividend income meets certain requirements, it can be taxed at a lower rate, with a maximum of 15% as it is considered a qualified dividend. You can simply review your 1099-DIV to see if any portion of your dividend income is qualified.

Lowering Your Taxable Income

Even if your income is taxed at the normal rate, there are ways you can legally lower your taxable income.

Tax Deductions and Credits

Don’t be afraid to claim all of the tax deductions and credits that you deserve. Utilizing them can help you reduce your taxable and lower your tax liability. Just a few popular ones include:

  • Mortgage Interest Deduction- This allows you to deduct your mortgage interest you paid the previous year. For us, we paid about $5,500. Note: To take advantage of this deduction you have to itemize.
  • Child Care Credit- The maximum you can claim with each child (provided they qualify) is $1,000.
  • Medical Expenses- You can deduct medical expenses whether you have kids or not. The IRS requires that your expenses exceed 7.5% of your adjusted gross income.
  • Business Expenses-
  • Lifetime Learning Credit- You can get a credit for up to $2,000 for qualified education expenses.

Using tax preparation software can be helpful in showing you what credits and deductions you qualify for as you file your taxes.

Contribute to a 401(k)

If you haven’t already, enrolling in your company’s 401(k) program can save you money with taxes AND help you with your retirement goals. Money contributed to your 401(k) is sent in pre-tax, which lowers your taxable income a bit.

Start small (5%) and increase your contributions whenever your income increases.

Thoughts on Taxable Income

I’d love to hear your take on lowering taxable income. What percentage of your income is taxable? What ways do you use to lower it legally?

About Elle Martinez
Elle Martinez helps families at Couple Money achieve financial freedom by sharing tips for reducing debt, increase income, and building net worth. Learn how to live on one income and have fun with the second..

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