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Tax Tip: What You Need to Know about Taxable and Non-Taxable Income
“All income is taxable unless there is a specific law that states the particular type of income is not taxable,” said Christina Wenk, a senior tax manager with WNDE. She offered some basic rules you should know to help you file an accurate tax return:
- Taxable income. Taxable income includes money you earn, like wages and tips. It also includes bartering, an exchange of property or services. The fair market value of property or services received is normally taxable.
- Life insurance. Proceeds paid to you upon the death of an insured person are usually not taxable. However, if you redeem a life insurance policy for cash, any amount you get that is more than the cost of the policy is taxable.
- Qualified scholarship. In most cases, income from a scholarship is not taxable. This includes amounts used for certain costs, such as tuition and required books. On the other hand, amounts you use for room and board are taxable.
- Other income tax refunds. State or local income tax refunds may be taxable. You should receive a Form 1099-G from the agency that paid you. They may have sent the form by mail or electronically. Contact them to find out how to get the form. Report any taxable refund you got even if you did not receive Form 1099-G.
Here are some items that are usually not taxable:
- Gifts and inheritances
- Child support payments
- Welfare benefits
- Damage awards for physical injury or sickness
- Cash rebates from a dealer or manufacturer for an item you buy
- Reimbursements for qualified adoption expenses
Christina also noted that some income items are taxable for federal purposes and not taxable for California purposes, such as state tax refunds being only taxable for federal purposes and only if you received a benefit from the deduction in a prior year. Some income items are taxable for California purposes and not taxable for federal purposes. For example, HSA contributions are deducted from wages when figuring your W2 taxable federal wages but HSA contributions are not allowed as a reduction to California W2 wages or as any kind of a deduction for California income tax purposes. When preparing your California income tax return, you must add your HSA contributions to your federal wages to obtain your California wages. You also have to include the interest or other earnings earned by your HSA account (not taxable for federal purposes) in California taxable income. It is important to know what to include and not to include in your taxable income as it directly affects your tax liability.
The More You Know: Income Tax Edition
If you are uncertain whether an item of income is taxable or nontaxable, consult your WNDE tax advisor, Christina advised. If you would like to read more on the subject of taxable and nontaxable income, see IRS Publication 525, “Taxable and Nontaxable Income.” Be sure to consider you are reading about federal tax law when reading this publication and that state laws may vary and often do.
Additionally, Christina offered “five interesting things you may not know about 2016 taxable vs. non-taxable income for individuals”:
- Some people who receive Social Security must pay federal income taxes on their benefits. A portion of Social Security benefits is taxed if income above a “base amount” (based on filing status) is received in addition to Social Security Benefits (IRS Sec. 86). However, no one pays federal income taxes on more than 85% of their Social Security benefits. Social security benefits are not subject to California income tax.
- Gambling winnings are fully taxable for federal and California purposes and you must report them on your tax return. For individuals who are not professional gamblers, gambling losses to the extent of gambling winnings are tax deductible as a miscellaneous itemized tax deduction and are not subject to the 2% floor of adjusted gross income. However, individuals who are not professional gamblers do not receive a deduction for losses at all if they don’t itemize deductions.
- In most cases, prepaid income, such as compensation for future services and advanced commissions is included in your income in the year you receive it. However, if you use an accrual method of accounting, you can defer prepaid income you receive for services to be performed before the end of the next tax year.
- Fringe benefits received from your employer are included in your income as compensation, unless you pay fair market value for them, or they are specifically excluded by law.
- Amounts you receive as workers’ compensation for a work injury or sickness are not taxable if they are paid under a workers’ compensation act or a statute like a workers’ compensation act. However, retirement benefits you receive based on your length of service, age, or prior contributions to the plan are taxable even if you retired because of a work injury or sickness.
Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. These are your Taxpayer Bill of Rights. Explore your rights and our obligations to protect them on IRS.gov.
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