Income Types

Wages reported in W-2 Box 1 are gross wages MINUS pre-tax deductions (traditional 401(k), pre-tax health premiums, HSA payroll contributions, dependent-care FSA). That is why Box 1 (federal wages) is often lower than Box 3 (Social Security wages) — SS wages are reduced only by Section 125 cafeteria items, not by 401(k) contributions.

Tips are taxable wages. Cash tips of $20 or more in a month must be reported to the employer by the 10th of the following month (Form 4070). Unreported tips are reconciled with Form 4137 and hit Schedule 2.

Not all fringe benefits are taxable. Excluded: employer-paid health insurance, group-term life insurance up to $50,000, qualified transportation up to monthly caps, working-condition fringes, de minimis fringes. Included: personal use of a company car, cash equivalents (gift cards).

Unemployment benefits are fully taxable at the federal level and reported on Form 1099-G, Box 1. The amount flows to Schedule 1, Line 7, and rolls into Form 1040 Line 8.

Federal income tax is NOT automatically withheld from unemployment. Recipients can voluntarily elect 10% withholding on Form W-4V. Many taxpayers who receive unemployment owe at year-end because they didn't withhold — a critical planning conversation.

State taxation varies: some states exempt unemployment entirely.

Social Security benefits (SSA-1099) are reported on Form 1040 Line 6a (gross) and Line 6b (taxable portion). The taxable amount depends on 'provisional income,' which is AGI (excluding SS) + tax-exempt interest + ½ of SS benefits.

Thresholds (unchanged for years):
• Single: 0% taxable if provisional < $25,000; up to 50% taxable $25k–$34k; up to 85% above $34,000.
• MFJ: 0% taxable if provisional < $32,000; up to 50% taxable $32k–$44k; up to 85% above $44,000.
• MFS (lived with spouse any time in the year): 85% taxable from dollar one.

SSA-1099 Box 5 shows the NET benefit received. Box 3 shows gross before any Medicare Part B withheld. Repayments (Box 4) reduce Box 3.

Interest. 1099-INT Box 1 is taxable interest (bank, corporate bonds, Treasury bonds partial). Reported on 1040 Line 2b. If interest + dividends exceed $1,500, Schedule B must be attached.

Municipal bond interest is FEDERALLY tax-exempt and goes on Line 2a. However, it counts toward provisional income (making SS more taxable) and is added back in the Alternative Minimum Tax if from 'private activity' bonds.

Dividends. 1099-DIV Box 1a = total ordinary dividends → 1040 Line 3b. Box 1b = QUALIFIED dividends → Line 3a. Qualified dividends are taxed at long-term capital gains rates (0%/15%/20%) if the holding-period requirement is met: more than 60 days held during the 121-day period beginning 60 days before the ex-dividend date.

Capital gain = sale price − adjusted basis. Basis starts as purchase price plus commissions, adjusted upward for improvements and reinvested distributions, downward for depreciation and prior nontaxable dividends.

Short-term = held one year or less; taxed at ordinary rates.
Long-term = held MORE THAN one year; taxed at 0%/15%/20% depending on taxable income.

Reported on Form 8949 (detail) → Schedule D (summary) → Form 1040 Line 7. The holding period starts the DAY AFTER acquisition. Gifted property retains the donor's basis and holding period (with special rules if FMV at gift is less than donor's basis). Inherited property gets a step-up in basis to fair-market-value at death (or alternate valuation date) and is automatically long-term.

Schedule C reports the net profit or loss of a sole proprietorship or SMLLC. The math: Gross receipts − returns/allowances − cost of goods sold (for product sellers) = gross income. Subtract deductible business expenses = net profit. Net profit flows two ways: to Schedule 1 Line 3 (for income tax) AND to Schedule SE (for self-employment tax).

Self-Employment Tax. Take net Schedule C profit × 92.35% = net earnings from SE (the 92.35% factor is the tax-adjusted portion that removes the employer-side FICA). Then apply 15.3% on earnings up to the Social Security wage base ($176,100 in 2025), and 2.9% Medicare on everything above that. High earners also pay an additional 0.9% Medicare surtax above $200,000 single / $250,000 MFJ.

Half of the SE tax is deducted above-the-line on Schedule 1 Line 15.

Rental real estate is reported on Schedule E. Gross rents minus operating expenses minus depreciation equals net rental income (or loss). Deductible operating expenses include mortgage interest, property tax, insurance, HOA dues, repairs, utilities paid by landlord, management fees, advertising, and travel.

Depreciation is mandatory for residential rentals — you must claim it whether you deduct it or not (unused depreciation reduces basis anyway when you sell). Residential rental depreciates over 27.5 years, straight-line, using mid-month convention. Commercial: 39 years.

Rental activity is per se PASSIVE under IRC §469. Passive losses are deductible only against passive income. Two big exceptions: (1) the $25,000 special allowance if you 'actively participate' — phased out $100K–$150K MAGI; (2) 'Real Estate Professional' status — see Chapter 7.