Income Definition: Types, Examples, and Taxes (2023)

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.

Key Takeaways

  • 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).
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Understanding Income

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.

Taxable Income

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.

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Ordinary 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

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.

Tax-Exempt Income

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.

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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.

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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.

FAQs

What is the definition and example of income? ›

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.

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 types of income in income tax? ›

As per the income tax act 1961, one's income is divided into 5 categories — income from Salary, income from house property, income from business profit, income from investments/capital assets and income from other sources.

What is the 3 types of income? ›

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 4 examples of income? ›

TYPES 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.

What are 5 types of income? ›

The 5 heads of income tax are:
  • Income from salary.
  • Income from house property.
  • Income from profits and gains from business or profession.
  • Income from capital gains.
  • Income from other sources.
Nov 17, 2022

What are taxes examples? ›

Types of taxes include income, corporate, capital gains, property, inheritance, and sales.

What are the types of tax examples? ›

Types of Taxes

You pay some of them directly, like the cringed income tax, corporate tax, wealth tax, etc., while you pay some of the taxes indirectly, like sales tax, service tax, value added tax, etc.

What are the three income taxes? ›

At least three federal taxes are imposed on wage and salary income: income tax, Social Security tax, and the Medicare tax.

What are 10 types of taxable income? ›

What is taxable income?
  • 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.

What does income mean in tax? ›

Your taxable income is the income you have to pay tax on. The taxable amount is the amount left after you claim a deduction for all the expenses you can. These amounts reduce the amount of assessable income you pay tax on. Assessable income − allowable deductions = taxable income.

What are the six 6 sources of income? ›

Aside from diversification, there are other ways to generate income known as the seven streams of income;
  • Earned Income.
  • Profit Income.
  • Interest Income.
  • Dividend Income.
  • Rental Income.
  • Capital Gains Income.
  • Royalty Income.
Apr 10, 2022

What are the different names of income? ›

Synonyms of income
  • revenue.
  • profit.
  • earnings.
  • return.
  • proceeds.
  • incoming(s)
  • yield.
  • gain(s)

Which type of income is taxed the most? ›

Key Takeaways
  • The top one percent paid the most in federal income taxes in 2019.
  • Your overall tax rate won't go up if your salary goes up, since higher tax rates only affect part of your income.
  • The United States tax system is progressive, which means that those who earn more money pay a higher percentage in taxes.
Nov 2, 2022

What is the top 10 income? ›

Landing in the top 10% is a fairly attainable goal for upwardly mobile Americans. 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.

What are the 7 sources of income? ›

7 Income Streams That Make Millionaires Rich
  • Capital Gains From Appreciated Assets. ...
  • Dividend Income. ...
  • Interest Payments. ...
  • Rental Income. ...
  • Business Income. ...
  • Earned Income. ...
  • Royalties and Selling Rights.
Oct 31, 2022

What are the two 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 is the top 5 income in the US? ›

Annual Wages of Top Earners
2020 Average Annual Wages
GroupAvg. Wages
Top 1% of Earners$823,763
Top 5% of Earners$342,987
Top 10% of Earners$173,176
1 more row

What are the 5 main taxes? ›

In fact, when every tax is tallied – federal, state and local income tax (corporate and individual); property tax; Social Security tax; sales tax; excise tax; and others – Americans spend 29.2 percent of our income in taxes each year.

What is a tax Short answer? ›

A tax is a sum of money that people pay to the government for the services provided by the government.

What are 3 direct taxes examples? ›

Direct taxes include:
  • Individual Income Tax.
  • Corporate Income Tax.
  • Capital Gains Tax.
  • Estate Tax.
  • Property Taxes.

How many types of taxes are there in? ›

When it comes to taxes, there are two types of taxes in India - Direct and Indirect tax. The direct tax includes income tax, gift tax, capital gain tax, etc while indirect tax includes value-added tax, service tax, goods and services tax, customs duty, etc.

What are the two types of taxes? ›

Every tax levied is backed by a law passed by the Parliament or the State legislature. We pay taxes in different forms, and the list of taxes in India differs based on their implementation and how they are paid to the authorities. Mainly, there are two types of taxes, direct and indirect tax.

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.

What are the 7 types of taxes? ›

Here are seven ways Americans pay taxes.
  • Income taxes. Income taxes can be charged at the federal, state and local levels. ...
  • Sales taxes. Sales taxes are taxes on goods and services purchased. ...
  • Excise taxes. ...
  • Payroll taxes. ...
  • Property taxes. ...
  • Estate taxes. ...
  • Gift taxes.
Jan 4, 2014

What is the full meaning of income? ›

Definition: Income is the revenue a business earns from selling its goods and services or the money an individual receives in compensation for his or her labor, services, or investments.

Why is income taxed? ›

Together with payroll taxes (used to fund social programs like Social Security and Medicare), income taxes amount to roughly 80 percent of all federal revenue, and are the essential fuel on which our government runs.

What is basic income called? ›

Universal basic income (UBI), or basic income guarantee, is a government program that aims to address economic inequality and provide economic security through monthly direct cash transfers to every member of a community with no means testing.

What type of income is not taxable? ›

Nontaxable income won't be taxed, whether or not you enter it on your tax return. The following items are deemed nontaxable by the IRS: Inheritances, gifts and bequests. Cash rebates on items you purchase from a retailer, manufacturer or dealer.

What type of income is taxed the least? ›

Here are 14 examples of tax-free income that Uncle Sam's tax collector doesn't get to reel in.
  1. Educational assistance from your boss. ...
  2. Adoption help from your employer. ...
  3. Child support. ...
  4. Payments for caring for children. ...
  5. Workers' compensation. ...
  6. Life insurance proceeds. ...
  7. Some canceled debts. ...
  8. Energy conservation subsidies.
Dec 7, 2022

What income is tax free? ›

As per section 10(1), agricultural income earned by the taxpayer in India is exempt from tax. Agricultural income is defined under section 2(1A) of the Income-tax Act.

What are the 10 examples for income? ›

12 Examples of Income
  • Labour. A salary or wage that is paid in return for work.
  • Business Profits. The net income of a business that creates and captures value.
  • Tangible Assets. ...
  • Intangible Assets. ...
  • Capital Gains. ...
  • Dividends. ...
  • Interest. ...
  • Rent Seeking.
Sep 27, 2019

What is the official definition of income? ›

Income is money or value that an individual or business entity receives in exchange for providing a good or service or through investing capital.

Where is income defined? ›

Section 61(a) of the Internal Revenue Code defines gross income as income from whatever source derived, including (but not limited to) “compensation for services, including fees, commissions, fringe benefits, and similar items.” I.R.C.

What is an example of income quizlet? ›

An example of earned income is: money received from wages or salary before deductions. What is the difference between gross and net income? One is the money you receive before taxes and deductions, and the other is the money you have left to use after taxes and deductions.

What are some examples of other income? ›

Examples of other income include income from interest, rent, and gains resulting from the sale of fixed assets. Companies present other income in a separate section, before income from operations. Other income is income that does not come from a company's main business, such as interest.

What is a Top 5 income? ›

Top 5% income

You'll start to see dramatic shifts in the top 5%, where the EPI found the average earners significantly increased to $343,000 in 2020, up from $324,000 the year before.

What is the tax definition of income? ›

Generally, you must include in gross income everything you receive in payment for personal services. In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options.

What are the 6 types of income? ›

The 6 Types of Passive Income:
  • Profit Income.
  • Interest Income.
  • Dividend Income.
  • Rental Income.
  • Capital Gains Income.
  • Royalty Income.
Dec 16, 2022

What is the best definition of 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.

How do you classify income? ›

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 is income in a sentence? ›

Example Sentences

Farming is his main source of income. Even on two incomes, we're having a hard time keeping up with our bills. He earns a good income as a consultant.

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