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The Internal Revenue Service outlines four types of income categories. Gross income is your total income from all sources. Assessable income is what you earn from passive activities along with your employment income. Non-taxable income is exempt from federal income taxation. Taxable income is the amount that you’re taxed on after subtracting your tax credits and deduction. Increasing your non-taxable income sources is a way to help lower your tax bill.
Assessable income is all the income you earn for the tax year. The IRS considers your wages, salary and commissions along with bonuses, awards, cost-of-living allowances, contributions to nonqualified deferred compensation plans and employee fringe benefits as assessable income. Rental property income, royalties, partnership and S corporation earnings is also included in the assessable income category. The IRS considers disability payments, sickness and injury benefits, unemployment benefits and life insurance proceeds as assessable income.
Two different types of income can originate from the same source. A good example of this is life insurance proceeds. A loan from your insurance policy in excess of the premiums you paid is taxable, but the proceeds you receive when someone dies are not taxable. Other types of non-taxable income include child support payments, workers’ compensation benefits, welfare benefits and cash rebates from a dealer or manufacturer. Qualifying adoption expenses, gifts and inheritances, and compensation awards for sickness and injuries are also non-taxable income.
Taxable income is all the income you earn that doesn’t fall into an IRS non-taxable category. Along with wages, the IRS considers tip income, gambling winnings, dividends, interest, and life insurance loan proceeds in excess of paid premiums taxable income. Capital gains and losses, pensions and annuities, bartering income, farming and fishing income, passive activity income and losses, and stock options are all taxable. Scholarships, fellowship grants, Social Security and Railroad Retirement benefits, lump-sum distributions and retirement plan rollovers are considered taxable income.
Reducing Your Taxable Income
You can use income tax credits and tax deductions to legally reduce your tax bill. IRS credits including the Earned Income Credit, Child and Dependent Care Credit, Adoption Credit, Retirement Savings Contribution Credit and the Repayment of the First-Time Home Buyer Credit can reduce your taxable income on a dollar for dollar basis. You can take the standard deduction or deduct the home mortgage points, mortgage interest, educational expenses and medical and dental expenses you paid on Schedule A. The IRS gives you the option of using the greater of your itemized deductions or the standard deduction to further reduce your taxable income.
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