Income refers to the money you earn in exchange for labor, products, or investments. Depending on the context—taxation, financial accounting, or economic analysis—the definition of income can vary. For most individuals, income encompasses wages, salaries, investment returns, pension distributions, and other receipts. For businesses, income includes the revenue from selling services or products, and income from interest and dividends on their cash reserves. Economists take more complex views, focusing on aspects such as earnings, savings, consumption, and public finance.
Key Takeaways
- Broadly Defined: Income is any money, property, or other value received over a set period in exchange for services or products.
- Taxable Income: This is your gross income minus exclusions, exemptions, and deductions allowed under tax laws.
- Financial Focus: Financial regulators, businesses, and investors often focus on firms’ annual financial statements, prepared in accordance with generally accepted accounting principles (GAAP).
The Essence of Income
Different Definitions
Income definitions can vary, from focusing on total earnings like wages and salaries to investment returns like interest and dividends.
- Gross Income: The total value of your salary or payments without any deductions.
- Net Income: What’s left after deducting taxes and fees.
- Discretionary Income: Money available after paying necessary expenses, often crucial for budgeting purposes.
- Taxable Income: The portion of income eligible for income tax, which varies by jurisdiction.
Tax vs. Accounting Standards
While both taxation and financial accounting measure income, they serve different purposes. Tax laws incorporate special rules like statutory exclusions, exemptions, and allowances based on tax status, income source, and more. Financial accounting measures are more comprehensive, offering a clearer real-world financial situation than tax accounting does.
Inclusion of Foreign Income
U.S. citizens working abroad still need to file income taxes. For the 2023 tax year, up to $120,000 of foreign-earned income is exempt.
Taxable Income Framework
The tax code defines taxable income to reflect people’s actual financial positions. Personal revenue from all sources is combined, and deductions for expenses and losses are subtracted to determine what’s taxable.
Public Policy Impact
Policies often offer favorable taxation for certain income levels or activities, such as tax exemptions for government bonds and retirement savings.
Types of Income: A Closer Look
Ordinary Income
Ordinary income encompasses earnings from work, interest, regular dividends, rental income, pensions, and Social Security benefits. This income is taxed at rates ranging from 10% to 37%. Income from investments exceeding specific thresholds incurs an extra 3.8% net investment income tax.
Capital Gains
These gains arise from selling appreciated assets. In the U.S., long-term capital gains tax rates are 0%, 15%, or 20%, applicable to assets held for more than one year.
Tax-Exempt Income
Interest from certain bonds issued by government entities is tax-exempt. Federal bonds are usually exempt from state and local taxes, and some state and local bonds are federally tax-exempt.
Earned vs. Unearned Income
Earned Income: Income from work and business activities, such as salaries and self-employment earnings.
Unearned Income: Income from inheritances, capital gains, and dividends. Earned income is subject to payroll, Medicare, and Social Security taxes, while unearned income is not.
Business Income: Standard Accounting Practices
Businesses typically follow GAAP to calculate income and value, offering investors a comprehensive view through standard financial statements. These principles differ from tax codes, emphasizing a closer economic reality.
The Standard Definition of Income
The context—tax law, financial accounting—determines the definition of income. Concepts like gross income and taxable income are essential for tax purposes; net income is crucial in financial accounting.
Examples of Taxable and Non-Taxable Income
Taxable Income
Taxable income includes total income from all sources minus exclusions and allowable deductions.
Tax-Exempt Categories
Interest from state and local government bonds, certain agency debts, Roth individual retirement accounts (IRAs), and some charitable distributions are generally tax-exempt.
Non-Income Payments
Non-taxable income includes alimony, child support, cash rebates, and qualifying healthcare benefits. Some scholarship payments and life insurance benefits can be taxable depending on situations.
Net Income vs. Profit
Though often used interchangeably, net income and profit differ slightly. Net income is the total revenue minus all expenses, including taxes and depreciation. Profit generally refers to revenue remaining after specific expenses, indicating various profitability metrics like gross and operational profit.
Conclusion
Income is fundamental to economic activity—it’s a measure of net gain from work or business. Understanding its various forms and implications can help individuals and businesses to manage it efficiently, consider tax implications, and understand financial positions accurately.
Related Terms: earnings, revenues, investments, salaries, financial statements, taxable income, gross income, net income, GAAP
References
- Social Security Administration. “Gross and Net Income: What’s The Difference?”
- Federal Student Aid. “How Is Discretionary Income Calculated for the Pay as You Earn (PAYE) Plan?”
- FINRA. “Taxation of Retirement Income”.
- IRS. “Energy Incentives for Individuals”.
- Investor.gov. “Municipal Bonds”.
- IRS. “IRS Provides Tax Inflation Adjustments for Tax Year 2023”.
- Internal Revenue Service. “Topic No. 559 Net Investment Income Tax”.
- Internal Revenue Service. “Unearned Income”.
- IRS. “Topic No. 409, Capital Gains and Losses”.
- TreasuryDirect. “Treasury Bonds: Tax Considerations”.
- Internal Revenue Service. “Tax Exempt Bonds”.
- Marks Paneth. “GAAP vs. Tax-Basis Reporting: Choosing the Right Model for Your Business”.
- Intuit. “Taxable vs. Nontaxable Income: What You should Know”.
