Taxable income—what is it and how does it affect your taxes?
Most types of income are taxable based on IRS rules. This includes money you make from a job or self-employment, investment income, unemployment pay, lottery winnings, and many other income sources.
Only a few types of income are not taxable at the federal level. But IRS deductions, credits, and other adjustments can help reduce your taxable income and total tax bill.
How does your taxable income affect your taxes?
While most income must be reported on your taxes, the IRS allows you to make certain adjustments and exclusions to reduce your taxable income. Your final taxable income and tax bill are determined only after all allowed deductions and other adjustments are subtracted from your gross income.
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Gross income
All of the taxable income you receive for the year. You'll report it on your tax return (Form 1040). It includes all of your earned income, unearned income, and other taxable income before any deductions, credits, or other adjustments are subtracted.
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Modified adjusted gross income (MAGI)
Another income calculation you might hear about. It doesn't appear on your main tax form, but the IRS uses it to determine your eligibility for certain tax credits, as well as net investment income tax. It's your AGI with certain deductions or income added back in.
How does your final taxable income affect your tax bill?
Your final taxable income determines your tax bracket and tax rate. But all of your income isn't taxed at one flat rate. Instead, it's taxed in a graduated manner.
Here's an example:
Let's say you're a single filer. Your AGI for 2022 is $80,000 and your final taxable income after your standard deduction is $67,050 ($80,000 minus $12,950). Your marginal (highest) tax rate would be 22%. But your final taxable income would be taxed like this:
| Tax rates | 2022 tax brackets | Amount of your income taxed at this rate | Tax liability (rounded to the nearest dollar) |
|---|---|---|---|
| 10% | $0 to $10,275 | $10,275 | $1,028 |
| 12% | $10,276 to $41,775 | $31,500 | $3,780 |
| 22% | $41,776 to $89,075 | $25,275 | $5,561 |
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Taxable income: $67,050
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Total tax liability: $10,369
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This example uses 2022 tax rates and rules for single filers in the 22% tax bracket, which are likely to change in future years. It is for illustrative purposes only and should not be considered tax advice. For current tax rates and rules that apply to your specific situation, go to www.irs.gov.
Your effective tax rate
In this example, your effective (average) federal tax rate would be 13% ($10,369 divided by $80,000)—not a flat 22%.