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Taxable Income vs. Gross Income: An Overview
Gross income includes all income that you receive from any possible source. Taxable income is the portion of your gross income that’s actually subject to taxation. Allowable deductions are subtracted from gross income to arrive at your taxable income.
Key Takeaways
- 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, and then certain allowable deductions are subtracted to arrive at your adjusted gross income.
- Adjusted gross income then can be reduced by the standard deduction or itemized deductions for the final amount of taxable income that will be taxed.
- Tax brackets and marginal tax rates apply to taxable income, not gross income.
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Taxable Income
Taxable income is the amount of the income you earn or otherwise receive that qualifies to be taxed. It can be reduced by adjustments, such as deductions, that are allowed by the Internal Revenue Service (IRS).
These are “above-the-line” adjustments to taxable income, made above the line on the tax form where adjusted gross income (AGI) appears. They can include contributions to a qualifying individual retirement account (IRA), student loan interest, and some contributions made to health savings accounts (HSAs).
Once these adjustments are made to your taxable income, you have your AGI. It then can be reduced by the allowable standard deduction or itemized deductions. These are “below-the-line” deductions (that appear below the AGI line on your tax return).
Standard Deduction
Taxpayers can take either the standard deduction allowed 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.)
When you subtract either your standard deduction or your itemized deductions from your AGI, the result is the final version of your taxable income. This is the amount that will be subject to taxation.
Claiming the standard deduction often reduces an individual’s taxable income more than itemizing deductions because the Tax Cuts and Jobs Act (TCJA) virtually doubled the amounts of standard deductions in 2018.
A taxpayer would need a significant amount of medical costs, charitable contributions, mortgage interest, and other qualifying itemized deductions to surpass these standard deduction amounts.
Gross Income
Gross income is all of your income that’s received from all sources before allowable deductions are taken.
Gross income includes:
- Wages, salary, tips, and self-employment (earned income)
- Unearned income not received from employment: dividends and interest earned on investments, rent, royalties, and gambling winnings
- Some withdrawals from retirement accounts, such as required minimum distributions (RMDs)
- Disability insurance income and unemployment income
- A portion of Social Security benefit payments
Gross business income is not the same as gross revenue for self-employed individuals. Rather, it’s the total revenues obtained from the business minus the cost of goods sold (COGS).
Gross income is any income 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.
Important
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.
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 2024 tax year, Joe claims an above-the-line adjustment to income for $3,000 in contributions he made to a qualifying retirement account. He then claims the $14,600 standard deduction for his single filing status. Therefore, his taxable income is $42,400 ($60,000 – $17,600).
While he had $60,000 in gross income, he will only pay taxes on his taxable income of $42,400.
Is Taxable Income the Same As Earned Income?
Taxable income in the sense of the final, taxable amount of our income, is not the same as earned income. However, taxable income does start out as gross income, because gross income is income that is taxable. And gross income includes earned and unearned income. Ultimately, though, taxable income as we think of it on our tax returns, is your gross income minus allowed above-the-line adjustments to income and then minus either the standard deduction or itemized deductions you’re entitled to claim.
How Can I Reduce My Taxable Income?
There are a number of ways to reduce your taxable income, some of which are only useful if you itemize your deductions. Here are a few ideas:
- Contribute the maximum to a 401(k) at work.
- Consider opening an individual retirement account (IRA). Be aware of the IRS rules on IRAs, as you may not be able to deduct your contribution under certain circumstances.
- Give to charity.
- Contribute to a high-deductible health savings account.
Are Social Security Benefits Taxed?
Your benefits may be taxable if the total of half of your Social Security benefits plus all your other income (including tax-exempt interest) is greater than the Social Security Administration’s base amount for your filing status.
The Bottom Line
Taxable income, as the actual amount of income to which taxes are applied, and gross income are not the same thing, but it’s easy to get confused about the difference.
Fortunately, not all of your gross income—which includes both earned and unearned income—is taxable, thanks to any and all deductions and credits that you can legitimately claim.
