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Understanding the Difference Between Taxable and Nontaxable Income

April 21st, 2014

You might think that all of your income is taxable, but there are actually several sources of income that may not be taxed at all or that have taxes deferred. It is important to know the differences between these types of income so that you are able to optimize your return this year. Read on to learn which sources of income fall into tax-free and tax-deferred categories.

Tax-deferred income

Certain types of savings accounts such as 401k plans are considered tax-deferred, because the money in the account is not taxed until it is being taken out. Money that is used to contribute to a 401k is not considered taxable income. Therefore, it may be beneficial for you to contribute a higher percentage of your income to your retirement fund.

Tax-free income

Roth IRAs work differently then 401k accounts, so they actually provide tax-free income during retirement. Income put into this type of account is taxed as normal, but there is no tax penalty on withdrawals. Scholarships and grants are not taxed with the exception of funds used for room and board. Life insurance benefits are another example of tax-free income, but this is only the case when the policy was not turned over to you for a price.

Taxable income

There are some sources of income that may be out of the ordinary, and these could make your tax situation more complex. Sources such as alimony payments, dividends, and rental income are all taxable income, so you will want to take this into account when these funds are received.

To better understand your tax situation, seek advice from the expert CPA team at the Firm of Flowers & Rieger. We have been providing tax preparation services in Tucson for more than 25 years, and we offer a free initial consultations for new clients. You can reach us on our website or at (520) 327-8706.

 

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