Income definition: types, examples and taxes (2023)

What is income?

Income refers to the money a person or organization receives in exchange for their work or products. Income can have different definitions depending on the context – for example taxes, financial accounting or economic analysis.

For most people, income means their total income in the form of wages and salaries, the return on their investments, pension payments, and other income. For businesses, income means the income from the sale of services, products and any interest and dividends they receive in relation to their cash accounts and reserves related to the business.

Economists have different definitions and methods of measuring income. Whether their studies are income, savings, consumption, production, public finance,capital investment, or other related topics and sub-topics, their concept of income will match the purpose of their research. While measuring income at the macro level is crucial to societal and political studies, individuals focus more on their personal and business income.

The central theses

  • The term "revenue" generally refers to the amount of money, property, and other transfers of value received over a period of time in exchange for services or products.
  • There is no single standard definition: income is defined according to the context in which the concept is used.
  • Taxable income is the result of determining the total or gross annual income of an individual or entity and reducing that amount by the exclusions, exemptions and deductions permitted by tax law.
  • Financial regulators, companies and investors focus on the financial statements of companies prepared in accordance withgenerally accepted accounting principles(GAAP).

understand income

Depending on the size to be measured, there are different income terms.gross incomemeans the total value of salary or payments, without taking into account cash incomerefers to the income remaining after deducting taxes or fees. For single earnersavailable incomeis the amount you have available after paying the necessary expenses.

For tax purposes, income refers to the types of income that are eligibleincome tax. These definitions may vary by jurisdiction - salaries and sales are usually considered part of one's owntaxable income, but inheritances and gifts are usually not.

Although tax and accounting rules share similarities, each system has specific rules that reflect its particular context and purpose. In general, taxes and financial accounting measure income over a 12-month period. While income from financial accounting is comprehensive, taxable income is calculated with special legal exemptions, allowances, and allowances that vary based on tax status, source of income, and individual and business decisions.

Taxable Income

For income tax purposes, the Tax Code attempts to define income as reflecting the actual economic position of the taxpayer. The general tax framework applies to taxpayers' personal income (other than tax-exempt income) from all sources and includes such incomedeductionsfor expenses and losses to determine taxable income.

In addition, government policies may provide favorable taxation for individuals with certain income levels or for preferred economic activities. These measures include tax exemptions on government bonds, tax breaks for pensions, tax credits for those below a certain income level and promotion of energy efficiency through special tax credits.

types of income

Three categories of income are of most concern to taxpayers: ordinary income, capital gains and tax-free income.

Ordinary Income

In the United States, tax law distinguishes ordinary income from investments. Ordinary income includes earnings, interest, periodic dividends, rental income, distributions from pensions or retirement accounts, and Social Security benefits. Ordinary income will be taxed at rates between 10% and 37% in 2022.

Taxpayers whose net investment income exceeds certain thresholds pay an additional 3.8% net investment income tax.

capital gain

Capital gains are the gains from the sale of assets that have appreciated in value. In the United States, theCapital Gains Tax Rateson assets held for more than one year are 0%, 15% and 20%. Investments include personal homes and investments such as real estate, stocks, bonds, and other financial instruments.

Qualifying Dividends – i. H. Dividends paid in respect of the stock holdings of US and certain foreign companies that meet the statutory holding period requirements are also taxed at the capital gains rate.

Tax-free income

Interest paid on certain government issued bonds is treated as exempt income. Interest on federal bonds andgovernment bondsis exempt from state and local taxes.

Interest on bonds issued by state and local governments is generally not subject to federal taxation. Municipal private bonds are not subject to ordinary federal income tax but are subject to the alternative federal minimum tax. Some states and local governments also exempt interest on state and local bonds from taxation.

How is earned income taxed?

Earned income is the money that a person receives as a result of work or business activities, such as B. earning a salary, income from self-employment or certain government benefits. This differs fromunearned income, such as B. an inheritance, capital gains or qualified dividends.

Earned income is subject to different taxes than unearned income. In the United States, earned income is subject to income taxMedicare tax, andsocial security tax, the latter being limited to a certain level.

Business Income: GAAP income

Most businesses, including all public companies, use standard financial accounting methods and practices—i.e. H. Generally Accepted Accounting Principles (GAAP) – to determine their income and value. Audited financial statements prepared in accordance with these rules are required for public companies. Investors evaluate companies' financial statements and use them to compare the performance of companies in the same or different industries.

GAAP calculations do not take into account the types of public policy deviations contained in tax laws. The two systems use different time standards for recording income and expenses. In general, the GAAP snapshot of earnings and enterprise value provides a picture of enterprise earnings and value that often more closely reflects economic reality than tax accounting results.

Is there a standard definition of income?

The definition of income depends on the context in which the term is used. For example, tax law uses the concepts of gross income, which includes all income in all its forms, and taxable income, which is gross income less expenses and other adjustments. On the other hand, the Financial Accounting Standard - Generally Accepted Accounting Principles (GAAP) - uses the term "income" to describe the total amount of all fees for products and services, and reduces that amount by expenses to determine net income. In addition, the calculation of income varies depending on the scope of the context – e.g. B. an individual, a household, an industry, a nation, etc.

What is taxable income?

Taxable income is the sum of all income from all sources and in any form, less any tax-exempt amounts or allowable deductions. This is the amount subject to income tax.

What types of income are tax-free?

Federal, state, and local tax laws establish certain categories of income that are not subject to income tax. Generally, interest paid on state and local government bonds is exempt from federal income tax. Federal law also exempts interest paid on some special narrow categories of federal agency debt. State tax laws exempt interest on US Treasury bonds, and some states also exempt interest on state and local bonds. In addition, distributions from Roth 401(k) plans and Roth Individual Retirement Accounts (IRAs) are tax-free. Charities and other tax-exempt organizations do not pay taxes on their income, except income from unrelated trades or businesses.

The final result

Income is one of the most basic measures of economic activity. For individuals and businesses, it measures the net profit of their earnings as a result of their work or business activity. In public policy, income forms the basis for most forms of taxation.

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