Tax Tip Tuesday: What Is Taxable vs. Nontaxable Income?

One of the most common questions taxpayers ask each year is: “Do I really have to report this as income?” The IRS doesn’t tax every dollar you receive — but it does tax most of them. Understanding what’s taxable and what’s not can help you prepare your return accurately, avoid penalties, and even plan better for the future.'

What Counts as Taxable Income?

The IRS defines taxable income as money, property, or services that you receive and can use as income. Some of the most common examples include:

• Wages and salaries – This includes hourly pay, salaries, tips, commissions, and bonuses. Your employer will report these on Form W-2.

• Self-employment income – If you freelance, contract, or run your own business, all amounts received (even through apps like Venmo, PayPal, or Stripe) are taxable. For 2025, expect continued IRS focus on third-party payment reporting.

• Investment income – This includes interest, dividends, and capital gains from selling stocks, bonds, or mutual funds. Even small amounts from savings accounts or crypto trades count.

• Retirement income – Distributions from traditional IRAs, pensions, or 401(k)s are generally taxable. Roth accounts may be tax-free if withdrawal rules are met.

• Rental income – If you rent out property, whether short-term (Airbnb, VRBO) or long-term, it must be reported. Expenses may offset taxable income, but the gross rents are still reportable.

• Unemployment benefits – These continue to be taxable at the federal level, even though some states exclude them.

  
  

In short, if you earn money by working, investing, or renting out property, you can expect the IRS to want its share.

What Counts as Nontaxable Income?

Not everything you receive increases your taxable income. Some common exclusions include:

• Gifts and inheritances – While very large gifts may trigger gift tax reporting for the giver, the person receiving a gift or inheritance doesn’t pay income tax on it.

• Life insurance proceeds – If you receive a payout because of someone’s passing, it is generally not taxable.

• Child support – Payments you receive for child support are not taxable. (Note: alimony for divorces finalized after 2018 is also not taxable to the recipient.)

• Qualified scholarships – Money used for tuition and required fees is tax-free, though funds used for housing or meals may be taxable.

• Workers’ compensation – Benefits for job-related injuries or illness are not taxable.

• Certain disability payments – Disability income may be nontaxable if you paid the insurance premiums yourself with after-tax dollars.

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These rules exist to prevent taxing the same money twice, or to protect individuals in specific financial situations.

The “Gray Areas” You Should Watch

Some income types depend on your specific situation:

• Social Security benefits – Depending on your total income, up to 85% of your Social Security may be taxable. Retirees often find this a surprise.

• Lawsuit settlements – Compensation for physical injury or illness is usually tax-free, but awards for lost wages, emotional distress, or punitive damages are taxable.

• Employer benefits – Some perks, like employer-provided health insurance or small de minimis benefits, are tax-free. But cash equivalents like gift cards, large awards, or commuting stipends may be taxable.

  
  

Because these categories vary, this is where a professional review can prevent errors.

Misreporting income can trigger IRS notices, audits, or penalties. On the flip side, overreporting can mean you’re paying more tax than you legally owe. Knowing the difference between taxable and nontaxable income is the first step toward an accurate tax return. If you’re ever uncertain about whether income is taxable, you can reach out to info@mkhstaxgroup.com for assistance.