Our tax system is straightforward in the sense that you pay taxes on taxable income. How much you pay will depend entirely on the type of income you receive.
Most income is taxable income but there are some examples of non-taxable income and we’ll look at both.
There are many types of taxable income. The income you earn from working as an employee is taxable, as is the income you earn when you are self-employed, or the income you receive as a business owner.
You are supposed to report income from wages, fees, commissions, tips, stock options and even fringe benefits. The fringe benefits you receive, even if you don’t receive cash, are taxable as income. Realize, too, that even if fringe benefits are given to someone else, or used by someone else, you are considered the recipient.
Investment income is also considered taxable. This includes income from the sale of investments; you pay capital gains on this income. You also pay taxes on income from interest earned on deposits, as well as from dividends paid out. Gains on collectibles sold (which includes physical metals) are also reported as taxable income.
You are also supposed to report and pay taxes on income from royalties. This includes royalties from copyrights, patents, and properties that produce mineral, oil and gas. Realize, too, that you pay taxes on bartering income. You will need to figure your gain for what you received in barter, although you can offset the income with the bartering services or items you provided.
There are a few income sources that aren’t taxable, here are some of them:
• Some disability insurance payments: While payments from a policy paid for by your employer are taxable, you don’t have to pay taxes on payments when you receive them from a plan that you pay for with after-tax dollars.
• Gift receipt: You don’t have to pay income taxes when you receive a gift. Taxes on gifts are paid by the giver – although the giver doesn’t have to pay taxes until the gift exceeds the exemption amount. Understand, though, that a prize isn’t a gift, and you pay taxes when you win a prize.
• Life insurance payout: You don’t pay taxes when you are the beneficiary of a life insurance policy.
• Municipal bond interest: When you invest in municipal bonds, they are most often tax-free at the federal level – and even usually at the state level (if you live in the state of issuance).