Taxable Income vs. Gross Income: An Overview
Gross income includes all income you receive that isn't explicitly exempt from taxation under the Internal Revenue Code (IRC). Taxable income is the portion of your gross income that's actually subject to taxation. Deductions are subtracted from gross income to arrive at your amount of taxable income.
- Gross income is all income from all sources that isn't specifically tax-exempt under the Internal Revenue Code.
- Taxable income starts with gross income, then certain allowable deductions are subtracted to arrive at the amount of income you're actually taxed on.
- Tax brackets and marginal tax rates are based on taxable income, not gross income.
Taxable income is a layman's term that refers to your adjusted gross income (AGI) less any itemized deductions you're entitled to claim or your standard deduction. Your AGI is the result of taking certain "above-the-line" adjustments to income, such as contributions to a qualifying individual retirement account (IRA), student loan interest, and some contributions made to health savings accounts.
Taxpayers can then take either the standard deduction for their filing status or itemize the deductible expenses they paid during the year. You're not permitted to both itemize deductions and claim the standard deduction. The result is your taxable income.
Claiming the standard deduction often reduces an individual's taxable income more than itemizing because the Tax Cuts and Jobs Act (TCJA) virtually doubled these deductions from what they were prior to 2018.
For the 2020 tax year, these deductions will increase slightly:
- For single taxpayers and married individuals filing separately, the standard deduction rises to $12,400, up $200 from the prior year.
- The standard deduction for married people filing jointly is $24,800, up $400.
- For heads of households, the standard deduction is $18,650, up $300.
The standard deduction for 2021 will be $25,100, an increase of $300, for married couples filing joint returns; $12,550, an increase of $150, for single taxpayers’ individual returns and married individuals filing separately; and $18,800, an increase of $150, for heads of households.
A taxpayer would need a significantly large amount of medical costs, charitable contributions, mortgage interest, and other qualifying itemized deductions to surpass these standard deduction amounts.
Gross income is the starting point from which the Internal Revenue Service (IRS) calculates an individual's tax liability. It's all your income from all sources before allowable deductions are made. This includes both earned income from wages, salary, tips, and self-employment and unearned income, such as dividends and interest earned on investments, royalties, and gambling winnings.
Some withdrawals from retirement accounts, such as required minimum distributions (RMDs), as well as disability insurance income, are included in the calculation of gross income.
Gross business income is not the same as gross revenue for self-employed individuals, business owners, and businesses. Rather, it's the total revenues obtained from the business minus allowable business expenses—in other words, gross profit. Gross income for business owners is referred to as net business income.
Some people confuse their gross income with their wages. Wage earnings often do make up the bulk of an individual's gross income, but gross income includes unearned income, too.
Gross income, however, can incorporate much more—basically anything that's not explicitly designated by the IRS as being tax-exempt. Tax-exempt income includes child support payments, most alimony payments, compensatory damages for physical injury, veterans' benefits, welfare, workers' compensation, and Supplemental Security Income. These sources of income are not included in your gross income because they're not taxable.
Taxable Income vs. Gross Income Example
Joe Taxpayer earns $50,000 annually from his job, and he has an additional $10,000 in unearned income from investments. His gross income is $60,000.
For the 2020 tax year, Joe claimed an above-the-line adjustment to income for $3,000 in contributions he made to a qualifying retirement account. He then claimed the $12,400 standard deduction for his single filing status. His taxable income is $44,600. While he had $60,000 in overall gross income, he will only pay taxes on the lower amount.