The IRS works hard to ensure that every American pays her share. Not every dollar given to a taxpayer is subject to federal tax. But a person who assumes that certain forms of income are tax-exempt or deductible might end up having filing complications or even an audit. Understanding the differences and details of gross income versus federal taxable income can help taxpayers get through tax season smoothly and pay only what they have to.
Definition of Gross Income
In the eyes of the IRS, gross income is essentially all money paid from any source. Most commonly this is monetary compensation from an employer. However, there are several other ways to make money, such as receiving payments on rental property, royalties from copyrights, patents and book sales, and income from investments and partnerships. Even the exchange of property, known as bartering, is considered a form of non-cash income based on the property's fair market value.
Definition of Taxable Income
The amount of income left after exemptions, deductions, or any other subtractions from gross income results in a taxpayer's "taxable income" or "taxable gross." Some people have a large difference between their gross and taxable incomes because of many deductions or exemptions. People with simpler employment situations might see very little difference.
There are a number of income sources that must be listed under gross income but generally are not considered taxable, including child support payments, workers' compensation benefits, and gifts. For example, if a single parent reports a gross income of $75,000 but $12,000 of that is from child support, his taxable income is only $63,000.
Getting From Gross to Taxable Figures
The process of determining a taxpayer's gross and taxable incomes typically involves itemizing deductions on her tax return. This particularly pertains to self-employed people who might want to write off business expenses such as use of a car, home office, and business-related travel costs. Charitable contributions and non-federal taxes paid during the year can also lower the federal taxable figure.
For other taxpayers, simply applying what is known as the standard deduction might be the only difference between gross and taxable income. The standard deduction is determined each year by the IRS, based on inflation. For example, a person filing single in 2010 is entitled to a $5,700 standard deduction. If this taxpayer had a gross income of $50,000 for the year, after the standard deduction her taxable income would be $44,300.
Filling out the proper tax forms with accuracy is crucial when calculating taxable income. The 1040 form contains steps to list and calculate all sources and amounts contributing to gross income as well as taxable income. These amounts must match up with any W-2 and 1099 forms provided by employers or paying entities, because the IRS has records of this income.
To claim deductions and lower taxable income, taxpayers typically use form 1040 Schedule C. A person with a gross income of $60,000 will enter this number into line seven of the form. If he accrued $2,000 worth of car expenses related to business and $4,000 in home office expenses, these will be entered into lines 9 and 30 respectively. His taxable income is now $54,000 and is entered into line 31.
The IRS watches closely over more complicated tax returns that show large differences between gross and taxable income. So taxpayers must be sure that they qualify for the types and amounts of deductions and exemptions that they claim.
- IRS.gov: What is Taxable and Nontaxable Income? Aug. 4, 2010
- IRS.gov: Topic 551 -- Standard Deduction, March 15, 2011
- IRS.gov: Taxable or Non-Taxable Income? Feb. 4, 2011
- IRS.gov: Form 1040, 2010
- IRS.gov: Form 1040 Instructions, 2010
- IRS.gov: Standard Deduction Worksheet, 2010
- Internal Revenue Service. "Publication 5307: Tax Reform Basics for Individuals and Families," Page 7. Accessed Nov. 30, 2019.
- Internal Revenue Service. "Revenue Procedure 2018-57," Page 16. Accessed Nov. 30, 2019.
- Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed Jan. 20, 2020.
- Internal Revenue Service. "Publication 525: Taxable and Nontaxable Income." Accessed Nov. 30, 2019.
Kara Page has been a freelance writer and editor since 2007. She maintains several blogs on travel, music, food and more. She is also a contributing writer for Suite101 and has articles published on eHow and Answerbag. Page holds a Bachelor of Music Education degree from the University of North Texas.