Taxable vs. nontaxable income

Is there a hard-and-fast-rule about what income is taxable and what income is not? The quick answer is that all income is taxable unless the law specifically excludes it. But there’s more to it than that.

Taxable income includes any money you receive, such as wages, tips, and unemployment compensation. It can also include noncash income from property or services. For example, both parties in a barter exchange must include the fair market value of goods or services received as income on their tax return.

Nontaxable Income

Here are some types of income that are usually not taxable:

Ӣ Gifts and inheritances
Ӣ Child support payments
Ӣ Welfare benefits
Ӣ Damage awards for physical injury or sickness
Ӣ Cash rebates from a dealer or manufacturer for an item you buy
Ӣ Reimbursements for qualified adoption expenses

In addition, some types of income are not taxable except under certain conditions, including:

Ӣ Life insurance proceeds paid to you are usually not taxable. But if you redeem a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.
Ӣ Income from a qualified scholarship is normally not taxable; that is, amounts you use for certain costs, such as tuition and required books, are not taxable. However, amounts used for room and board are taxable.
”¢ If you received a state or local income tax refund, the amount might be taxable. You should have received a 2022 Form 1099-G from the agency that made the payment to you. If you didn’t get it by mail, the agency might have provided the form electronically. Contact them to find out how to get the form. Be sure to report any taxable refund you received even if you did not receive Form 1099-G.

Tip Income

If you get tips from customers, you must pay federal income tax on any tips you receive. The value of noncash tips, such as tickets, passes, or other items of value, are also subject to income tax.

You must include the total of all tips you received during the year on your income tax return, such as tips received directly from customers, tips added to credit cards, and your share of tips received under a tip-splitting agreement with other employees.

Bartering Income

Bartering is trading one product or service for another. Small businesses sometimes barter to get products or services they need. For example, a plumber might trade plumbing work with a dentist for dental services. Typically, there is no cash exchange; however, if you barter, the value of products or services from bartering is considered taxable income by the IRS.

Barter and trade dollars are the same as real dollars for tax purposes and must be reported on a tax return. Both parties must report as income the fair market value of the product or service they get.

The tax rules may vary based on the type of bartering. Barterers may owe income taxes, self-employment taxes, employment taxes, or excise taxes on their bartering income. How you report bartering on a tax return also varies. For example, if you are in a trade or business, you normally report it on Form 1040, Schedule C, Profit or Loss from Business.

Taxes can be complicate and time consuming and costly if you make mistakes. This column is for information only and should not be taken as advice. Contact a tax professional if you have questions.

Norman G. Grill is managing partner of Grill & Partners LLC, certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien.