What Is Income?
Income refers to the money that a person or entity receives in exchange for their labor or products. Income may have different definitions depending on the context—for example, taxation, financial accounting, or economic analysis.
For most people, income means their total earnings in the form of wages and salaries, the return on their investments, pension distributions, and other receipts. For businesses, income means the revenues from selling services, products, and any interest and dividends received with respect to their cash accounts and reserves related to the business.
Economists have different definitions and ways of measuring income. Whether their studies involve earnings, savings, consumption, production, public finance, capital investment, or other related topics and subtopics, their concept of income will correspond to the purpose of their research. While the measure of income on a macro level is critical to societal and policy studies, individuals are more focused on their personal and business income.
- The term “income” generally refers to the amount of money, property, and other transfers of value received over a set 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 annual total or gross income of an individual or entity and reducing that amount by the exclusions, exemptions, and deductions allowed under the tax law.
- Financial regulators, businesses, and investors focus on businesses’ annual financial statements, which are prepared in accordance with generally accepted accounting principles (GAAP).
There are different terms for income, depending on the quantity being measured. Gross income means the total value of one's salary or payments, without accounting for any cash outflows. Net income refers to the income left over after subtracting taxes or fees. For individual earners, discretionary income is the amount they have available after paying for necessary expenses.
For the purposes of taxation, income refers to the types of revenues that are eligible for income tax. These definitions may vary by jurisdiction—salaries and sales are typically considered part of one's taxable income, but inheritances and gifts usually are not.
Although tax and accounting rules have similarities, each system has special rules reflecting its distinctive context and purposes. Generally, taxation and financial accounting measure income over a 12-month period. While financial accounting income is comprehensive, taxable income is calculated with special statutory exclusions, exemptions, and allowances that vary by tax status, income source, and individual and business decisions.
For income tax purposes, the tax code attempts to define income to reflect taxpayers’ actual economic position. The general tax framework applies totaxpayers’ personal revenue (other than tax-exempt income) from all sources and offsets such revenue with deductions for expenses and losses to determine taxable income.
In addition, public policies may offer favorable taxation for people at certain income levels or for favored economic activities. Such policies include tax exemptions for government bonds, tax-favored treatment for retirement savings, tax credits for people below a certain income level, and promoting energy efficiency through special tax credits.
Types of Income
Three categories of income are of principal concern to taxpayers: ordinary income, capital gain, and tax-exempt income.
In the United States, the tax law distinguishes ordinary income from capital investments. Ordinary income encompasses earnings, interest, regular dividends, rental income, distributions from pensions or retirement accounts, and Social Security benefits. Ordinary income is taxed at rates ranging from 10% to 37% in 2022.
Taxpayers whose net investment income exceeds specified thresholds pay an additional 3.8% net investment income tax.
Capital gains are the gains from selling assets that have appreciated in value. In the United States, the capital gains tax rates on assets held for more than one year are 0%, 15%, and 20%. Capital assets include personal residences and investments such as real estate, stock, bonds, and other financial instruments.
Qualified dividends—that is, dividends distributed with respect to the U.S. and certain foreign corporate stock holdingsthat meet statutory holding-period requirements—also are taxed at capital gains rates.
Interest paid on certain bonds issued by governmental entities is treated as tax-exempt income. Interest paid on federal bonds and Treasury securities is exempt from state and local taxation.
Interest on bonds issued by state and local governments generally is not subject to federal taxation. Municipal private activity bonds are not subject to the regular federal income tax, but they are subject to the federal alternative 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 a person receives due to working or business activities, such as earning a salary, self-employment income, or certain government benefits. This is distinct from unearned income, such as receiving 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 payroll taxes, Medicare tax, and Social Security tax, although the latter is capped at a certain level.
Business Income: GAAP Income
Most businesses, including all public companies, employ standard financial accounting methods and practices—i.e., 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 assess businesses’ financial statements and use them to compare the performance of companies in the same or different industries.
GAAP calculations do not incorporate the type of public policy deviations that are embodied in the tax code. The two systems employ different timing standards for recognizing revenue and expenses. Generally, the snapshot of income and business value determined using GAAP provides a picture of business income and value that is often closer to economic reality than the results of tax accounting.
Is There a Standard Definition of Income?
The definition of income depends on the context in which the term is used. For example, the tax law uses the concepts of gross income, which includes all income in all its forms, and taxable income, which is gross income net of expenses and other adjustments. On the other hand, the standard for financial accounting—generally accepted accounting principles (GAAP)—uses the term “revenue” to describe the comprehensive amount of all fees for products and services, and it reduces that amount by expenses to determine net income. In addition, the calculation of income will vary depending on the scope of the context—e.g., an individual, a household, an industry, a nation, etc.
What Is Taxable Income?
Taxable income is the total of all income from all sources and in any form, minus any tax-exempt amounts or allowable deductions. This is the amount that is subject to income taxation.
Which Categories of Income Are Tax-Exempt?
Federal, state, and local tax laws specify certain categories of income that are not subject to income taxation. 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 U.S. 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 tax on their income, except for income from unrelated trades or businesses.
The Bottom Line
Income is one of the most basic measures of economic activity. For individuals and companies, it measures the net gain of their revenues as a result of working or doing business. In public policy, income represents the basis for most forms of taxation.
What are examples of taxes on income? ›
- Individual Income Taxes. ...
- Corporate Income Taxes. ...
- Payroll Taxes. ...
- Capital Gains Taxes. ...
- Sales Taxes. ...
- Gross Receipts Taxes. ...
- Value-Added Taxes. ...
- Excise Taxes.
Three of the main types of income are earned, passive and portfolio. Earned income includes wages, salary, tips and commissions. Passive or unearned income could come from rental properties, royalties and limited partnerships. Portfolio or investment income includes interest, dividends and capital gains on investments.What are the 3 types of taxes and examples? ›
progressive tax—A tax that takes a larger percentage of income from high-income groups than from low-income groups. proportional tax—A tax that takes the same percentage of income from all income groups. regressive tax—A tax that takes a larger percentage of income from low-income groups than from high-income groups.What are the examples of income? ›
- Wages. This is income you earn from a job, where you are paid an hourly rate to complete set tasks. ...
- Salary. Similar to wages, this is money you earn from a job. ...
- Commission. ...
- Interest. ...
- Selling something you create or own. ...
- Investments. ...
- Gifts. ...
- Allowance/Pocket Money.
- Income from salary.
- Income from house property.
- Income from profits and gains from business or profession.
- Income from capital gains.
- Income from other sources.
The World Bank assigns the world's economies to four income groups—low, lower-middle, upper-middle, and high income. The classifications are updated each year on July 1 and are based on the GNI per capita of the previous year (2021).What are 2 types of income? ›
What are Types of Income? There are two kinds of income: Earned income and unearned income. Earned income is money you make while actively working, like being employed or running your own business. Unearned income typically includes investment, retirement, and passive income.What are the six 6 sources of income? ›
- Earned Income.
- Profit Income.
- Interest Income.
- Dividend Income.
- Rental Income.
- Capital Gains Income.
- Royalty Income.
- Sales taxes are paid by the consumer when buying most goods and services. ...
- Income taxes are paid on many sources of income you might earn, like the taxes taken directly from your paycheck.
- Individual Income Tax.
- Corporate Income Tax.
- Capital Gains Tax.
- Estate Tax.
- Property Taxes.
How many types of income tax are there? ›
Taxes are of two different types; direct tax and indirect tax. Taxes charged on income earned is called direct tax.What is income Give 5 examples? ›
Ordinary income encompasses earnings, interest, regular dividends, rental income, distributions from pensions or retirement accounts, and Social Security benefits.What are different types of taxes? ›
In a broader term, there are two types of taxes namely, direct taxes and indirect taxes. The implementation of both taxes differs.What kind of tax is income tax? ›
income tax, levy imposed on individuals (or family units) and corporations. Individual income tax is computed on the basis of income received. It is usually classified as a direct tax because the burden is presumably on the individuals who pay it.What are the different types of income source? ›
- Income #1: Earned Income. This is the primary source of income. ...
- Income #2: Investment Income. This is the income that is generated by selling investments that were made earlier. ...
- Income #3: Passive Income. Passive income is another important source of income.
- Capital Gains From Appreciated Assets. ...
- Dividend Income. ...
- Interest Payments. ...
- Rental Income. ...
- Business Income. ...
- Earned Income. ...
- Royalties and Selling Rights.
Income is money or value that an individual or business entity receives in exchange for providing a good or service or through investing capital.What are 4 sources of income? ›
- Earned income: This is your day job and most people's primary source of income. ...
- Business income: You own a business. ...
- Interest income: This is income you make from lending your money out. ...
- Dividend income: This is money that's distributed as a result of owning shares of a company.
- Rental income. If you've got a large chunk of change, some inheritance, or have saved up a lot of money, you might consider getting some rental income on the side. ...
- Earned Jobs and Side Gigs. ...
- Dividends. ...
- Running your own business. ...
- Royalties. ...
- Interest. ...
- Capital gains. ...
- Become a landlord.
- Cost of goods sold.
- Operating expenses.
- Dividends on preferred stocks.
What is personal income tax? ›
The individual income tax (or personal income tax) is a tax levied on the wages, salaries, dividends, interest, and other income a person earns throughout the year. The tax is generally imposed by the state in which the income is earned.What are three basic taxes? ›
- Schedule 1 (Form 1040) Additional Income and Adjustments to Income. USE IF... ...
- Schedule 2 (Form 1040), Additional Taxes. USE IF... ...
- Schedule 3 (Form 1040), Additional Credits and Payments. USE IF …
The four most used tax bases are individual income, corporate income, sales, and property.What are examples of indirect tax? ›
- Sales Taxes.
- Excise Taxes.
- Value-Added Taxes (VAT)
- Gross Receipts Tax.
Examples of indirect taxes include sales tax, excise tax, value-added tax, and tariffs.What is direct and indirect taxes with examples? ›
Whether you're a salaried individual or businessman, one has to pay both direct or indirect taxes. Direct taxes can be in the form of income tax, capital gains tax or securities transaction tax, while indirect taxes such as GST, Customs Duty or VAT are levied on all end-consumers to buy any goods services.What is the top 10 income? ›
Top 10% income
A study by the Economic Policy Institute (EPI), found that the average earnings of those in the top 10% were roughly $173,000 in 2020.
- wages, salaries, tips, bonuses, vacation pay, severance pay, commissions.
- interest and dividends.
- certain types of disability payments.
- unemployment compensation.
- jury pay and election worker pay.
- strike and lockout benefits.
- bank “gifts” for opening or adding to accounts if more than “nominal” value.
- Profit Income.
- Interest Income.
- Dividend Income.
- Rental Income.
- Capital Gains Income.
- Royalty Income.
How many types of income are there? ›
Some common forms of income are salary, rent, capital gains, business income, and income from other sources. It's not always easy to know how each kind of income is taxed, and you may need an income tax calculator to develop an understanding.