You work hard, only to see a large chunk of money come out of each paycheck. At tax time, you may owe even more, provided your employer didn’t hold enough out of your pay. But not all of the income you bring in each year is subject to taxation. The portion of all of the income you earn used to calculate your tax debt is called assessable income. But once you’ve eliminated credits and deductions, you get the amount of your income known as taxable income.
Assessable income is all of the taxable income you earn each year. Taxable income refers to the income remaining after that year’s credits and deductions are applied.
Assessable Income vs. Taxable Income
Each year, you earn income that is subject to taxation. This is assessable income. It can be confusing, but it helps to think of assessable income as your starting point. This is all the money you bring in that the IRS taxes. However, each year, you have deductions and tax credits that help you keep some of that assessable income. It’s only after you take those deductions and tax credits that you’re then looking at the portion of your assessable income that is officially taxable.
Taxable income is simply the amount of your income that remains after you’ve taken all the deductions and credits for the year. If your gross income is $50,000, but you have $10,000 in tax credits and deductions, you’ll pay taxes on only $40,000. Taxable income includes everything on the forms you use to file your taxes each year, including your wages, tips and bonuses, as well as unearned income like interest and Social Security.
Taxable Income Versus Nontaxable Income
Not all the income you receive each year is subject to taxation. Disability benefits, for instance, are taxable if they’re provided by your employer since they’re similar to earning a salary. If, however, you paid for the disability policy with after-tax dollars, you won’t have to pay taxes on it when you use it. If you received workers' compensation or damages from a personal injury claim, you won’t pay taxes on that, either.
You can also receive income in the form of a gift from a family member, as long as the amount doesn’t exceed $15,000 per year. In some instances, inheritances and life insurance payouts aren’t taxable, nor are certain investment payouts. If you’re receiving Social Security, you can also enjoy that money tax-free, as long as your combined total income does not exceed the IRS’s base amount. Currently, the base limit is $25,000 if you’re a single filer or $32,000 if you’re married filing jointly.
Gross Versus Net Income
You’ll likely more often see the concepts of gross and net income discussed. Gross income refers to the money that comes in before anything is taken out of it. For individuals, that refers to the salary or hourly pay you’re quoted when you’re hired. For businesses, it’s the amount of money that comes in before any expenses are taken out. If you’re selling products in a store, for instance, gross income would be the amount you made before things like inventory and payroll costs are factored into the amount. If you’re keeping books, your gross income will be the amount you made without taking into consideration all of the expenses you also are tracking.
Net income, on the other hand, is the amount you actually have on hand, once all is taken out. If you’ve ever received a paycheck, you know the amount you’re quoted as a salary is not what you take home. Taxes, medical premiums and other items are withheld from each paycheck and your employer manages things from there. Businesses look at net income as the amount they have left over each month once the bills are paid. Although gross income can speak volumes about how well a business is marketing its services, net income is the true gauge of the health of a company. Businesses also pay taxes, which are taken from gross income to give them a much lower net.
Credits That Decrease Assessable Income
You may also think of your assessable income as your accessible income, as in the part of your income the IRS can access. There are things you can do each year to reduce the amount the IRS can tax, which means more money in your bank account. If you have children, you’ll start with the tax credits offered each year. The Child Tax Credit will give you $2,000 per child, with up to $1,400 of that being refundable. That means if you don’t owe any taxes, you’ll get a check for $1,400. Parents can also take the Child and Dependent Care Tax Credit, which offers $3,000 for qualifying care expenses for children or adult dependents in your household.
Going back to school can help you to tax savings. You can claim 100 percent of the first $2,000 of post-secondary education expenses, as well as 25 percent of the next $2,000. This brings a maximum annual credit of $2,500. There’s also the Lifetime Learning Credit, which lets you claim up to 20 percent of qualifying education expenses, maxing out at $2,000 per year. If you have already graduated and you’re dealing with student loans, you can claim some of the interest on that, as well. The IRS will allow you to deduct up to $2,500 each year for the interest you paid on your student loans, as long as your loan meets the IRS’s requirements.
Deductions That Decrease Assessable Income
In addition to credits, there are also deductions that can help you reduce your assessable income. You can claim medical expenses above 7.5 percent of your taxable income. You can also claim any charitable donations up to 60 percent of your income. Save receipts and document these deductions in case you’re audited.
Self-employed taxpayers and small business owners can take deductions to reduce what they owe. This includes any business equipment or furniture you purchased. You can claim the cost of utilities to support your business, even if you work from home, as long as you eliminate the percentage of the expense for personal use. You can claim your home office, legal and professional costs, travel expenses and any education expenses related to building and growing your business.
Taking the Standard Deduction
After the Tax Cuts and Jobs Act, many taxpayers may reconsider taking deductions. Each taxpayer is given a $12,000 standard deduction, with heads of households allowed to take $18,000 and married couples filing jointly claiming $24,000. Seniors and blind taxpayers can add $1,300 to that amount and unmarried taxpayers can increase it to $1,600. Consider whether you’re likely to compile more than that in itemized deductions for the tax year to save yourself some time.
One thing that is going away this year that reduced taxable income in the past is the personal exemption. This makes it a little more difficult to determine whether you made enough income to file a tax return. This year, you’ll need to file a tax return if your gross income exceeds the standard deduction. This means single dependents will need to file a return if they earn more than $12,000, while married taxpayers filing jointly must file if they made more than $24,000 in the tax year.
Pretax Savings Accounts
Another way to offset your IRS chargeable income is to take advantage of the many pretax savings options now available. One of the most popular of these is the medical savings account, which is set up by employers to allow workers to set a certain amount of pretax dollars aside each month for health care costs. You’ll need to enroll in a high-deductible plan meeting the IRS’s requirements and you’ll only be able to use the money for approved medical expenses, such as doctor’s appointments and prescription medications. The good news is if you don’t use the money, it continues to accumulate until you use it, which makes it a handy retirement plan.
Another type of pretax savings account is the Dependent Care FSA, which lets you set money aside for expenses like child care, summer camp, after-school programs and adult day care for your senior dependents. By putting money into a savings account before taxes have been taken from it, you’ll be able to save up to 30 percent on your expenses. You can enroll in Dependent Care FSA through FSAFEDS during the enrollment period toward the end of each year. However, as with medical savings accounts, you’ll have to enroll through your employer, since the money is taken out of your paycheck.
Investments to Reduce Assessable Income
Instead of handing money over to Uncle Sam each year, there are ways you can invest your money with minimal tax repercussions. The most popular of these is a retirement savings account. If your employer offers a 401(k), you should consider participating, especially if your contributions are matched. A 401(k) puts your money into the account before taxes are taken out, but you will need to pay taxes when you take it out at retirement. If you aren’t participating in an employer-sponsored retirement savings plan, you can also contribute up to a certain amount each year tax-free to an IRA.
If you’d prefer to pay taxes now and save later, you can instead contribute to a Roth 401(k) or Roth IRA. You won’t save on taxes now since the money goes in after taxes have been taken out on it, but when you reach retirement age, you’ll be able to withdraw the money tax-free. If your employer is making contributions into your Roth 401(k), though, you won’t get a tax break when you take that part of the account out during your senior years. You’ll also need to follow the IRS’s rules when it comes to taking the money out to avoid being hit with taxes or penalties.
Energy Tax Credits
Another way to reduce the amount of your income that can be taxed is to invest in small things that can help improve the planet. If you’re upgrading your home or making a new vehicle purchase this year, pay close attention to any tax credits available. This will offer a cost savings in addition to what you’ll see in the form of lower utility bills and post-purchase rebates. One of the biggest savings comes with the Plug-in Electric Drive Vehicle Credit. If you buy an electric vehicle and it qualifies, you’ll see a $7,500 tax credit. Unfortunately, though, each type of car has a “phaseout” in effect that only allows a certain number of purchasers of each manufacturer to qualify for the credit.
If you add solar power to your home, you could qualify for a credit worth 30 percent of your purchase price. This includes items like solar panels for your roof and solar hot water systems. Unfortunately, the IRS has ended the credit for other types of energy efficiency, but your state may still issue credits for this on your state income tax, so it can’t hurt to check.
- Cambridge Dictionary: Definition of “assessable income” - English Dictionary
- Cambridge Dictionary: Definition of “taxable income” - English Dictionary
- Investopedia: Taxable Income
- Investopedia: 10 Sources of Nontaxable Income
- Smart Asset: Is Social Security Income Taxable?
- MBO Partners: Gross Income vs. Net Income: What is the Difference?
- Smart Asset: All About Child Tax Credits
- MarketWatch: Beat the system when claiming tax breaks for education under the new tax law
- Discover: How the New Tax Law Affects Paying for Higher Education
- Reader's Digest: 11 New Tax Deductions and Reductions Under the New Tax Law
- Bench: The Big List of Small Business Tax Deductions (and How to Claim Them)
- Forbes: New: IRS Announces 2018 Tax Rates, Standard Deductions, Exemption Amounts And More
- FSAFEDS: Dependent Care FSA
- Investopedia: How Is Your 401(k) Taxed When You Retire?
- Energy Sage: 2018 energy tax credits that can save you money