Income Definition

What Is Income?

Revenue is the money an individual or organization gets for their services or goods. Depending on the context-such as taxes, financial accounting, or economic analysis-income may have a variety of meanings.

Most individuals' overall profits include wages and compensation, investment returns, pension payments, and other disbursements. For companies, income refers to the money made from providing goods and services and any interest or dividends paid on the company's capital holdings and reserves.

Economists use different meanings and methods of calculating revenue. Their notion of income will align with their study's goal, regardless of whether it involves wages, savings, spending, output, public finance, capital investment, or other connected subjects and subtopics. Although a macroeconomic gauge of income is important for social and policy studies, people tend to be more concerned with their personal and company income.

The first source of money that comes to mind may be your salary. But additional sources of money might include:

• Obtaining tips and fees in addition to your normal pay or wage
• Making a business by offering products or services
• Earning financial profits, dividends, or interest from assets
• Winning honours, rewards, and scholarships
• Getting presents, money, or inheritances
• Getting federal aid and tax credits
• Taking money out of retirement or annuity accounts

Understanding Income

Depending on the amount being measured, multiple phrases apply to income. Gross income is the sum of a person's wages or other payments, excluding cash outlays. Net income is the money that remains after deducting taxes and other expenses. Individual wage workers' discretionary income is the amount left over after covering necessary costs.

Income is the term used to describe the many revenue forms subject to income tax. Salaries and sales are often regarded as a portion of one's taxable income, although inheritances and gifts are typically not; these definitions may vary by jurisdiction.

Although there are some similarities between tax and accounting laws, each system has unique rules that reflect its context and aims. Financial accounting and taxation typically measure income over 12 months. Financial accounting income is complete, but taxable income is determined using unique statutory exclusions, exemptions, and allowances that depend on the taxpayer's tax situation, income source, and personal and professional choices.

Earned Income

According to the Internal Revenue Service, earned income includes daily wages, employee salaries, bonuses, commissions, tips, and net earnings from being self-employed. It may also include things like disability benefits, benefits from union strikes, and deferred retirement fund payments.

As was already mentioned, it includes a variety of sources of revenue that one can obtain through a job or as an employee working for a company. Any revenue from work or self-employment falls under one of these income groups, which aligns with the Internal Revenue Service's guidelines. Earned revenue does not include money obtained through other assets or from receiving government benefits. If taxpayers meet the requirements, they may be granted a tax refund on their earned income despite having a relatively low family income.

When it comes to taxes, the definition of earned income is comparatively simpler: it refers to any money derived from work performed for an employer or on a self-employment footing. The various types of income that are not categorized include alimony, money accumulated from non-deferred pension plans, capital gains from the sale of the property, interest from savings accounts or other investments, dividends from stock investments, interest from bonds, and any passive income derived from a source of rental property. Generally speaking, both earned money, and other types of revenue are subject to taxation, though the applicable tax percentage may change.

What Qualifies Earned Income?

• Earned income has a significantly smaller risk-reward relationship than income from a business.
• The feeling of business is eliminated, and individuals are more likely to labour for compensation.
• People can benefit from the benefit and reduce their tax responsibilities to the government by taking advantage of a few tax cuts and allowances.
• One must learn how to support oneself on a limited income and never pursue endeavours that require greater outlays of money.

Advantages

• Earned earnings serve subsistence for those who favour salaried employment but cannot operate their businesses.
• In contrast to business, where risk is also high, and it may occasionally experience loss, it is more of a steady type of revenue assured every month or day based on the arrangement.
• Compared to the company, the risk-reward connection is relatively low, but the security of the revenue produced is higher.
• Additionally, it includes tipping, which serves as an additional source of income for some sectors with poor starting salaries.
• From a revenue perspective, earned income significantly boosts the economy through tax payments that enable the government to use the money for the public advantage.

Disadvantages

• Compared to a company's income, earned income has a comparatively lower risk-reward relationship.
• It eliminates the sense of business and increases people's propensity to work for pay.
• People can take advantage of a few tax breaks and exemptions to profit from the benefit and lower their tax obligations to the government.
• One must learn to live on a fixed salary and never aim for other endeavours that demand larger investments.

Taxable Income

The tax law tries to define revenue for income tax reasons in a way that reflects taxpayers' real economic circumstances. The general tax structure applies to all personal income individuals receive (other than income free from tax). It reduces that income by reductions for expenditures and losses to arrive at taxable income.

Furthermore, state policies might provide advantageous taxes for those who earn a certain amount or for particular types of businesses. Government assets are exempt from taxes, retiree funds receive special tax treatment, low-income individuals are eligible for tax rebates, and energy efficiency is promoted through specialized tax incentives.

Capital Gains

Gains from selling commodities that have increased worth are known as capital gains. The capital gains tax rates in the US are 0%, 15%, and 20% for investments kept for more than a year. Personal homes and interests in real estate, stocks, bonds, and other financial products are considered capital goods.

Qualified dividends, or those paid about U.S. and specific foreign company stock holdings that satisfy statute holding-period requirements, are also subject to capital gains tax rates.

Ordinary Income

The tax code in the US differentiates between capital assets and ordinary income. Earnings, interest, monthly dividends, leasing income, payments from pensions or retirement funds, and Social Security benefits are all considered part of ordinary income. In 2023, the tax percentage on ordinary revenue will range from 10% to 37%. The additional 3.8% net investment income tax is paid by taxpayers whose net income surpasses certain limits.

Income Inequality

The degree to which money is spread inequitably is known as income inequality. Numerous techniques can quantify it, such as the Lorenz curve and the Gini statistic. Numerous economists contend that while some inequality is essential and desirable, excessive inequality causes issues with productivity and societal injustice. Thus, programs like the Sustainable Development Goal 10 of the United Nations, which aims to reduce disparity, are required.

The overall income of people, businesses, and the government in the economy is quantified by net national income (NNI). See Metrics of National Income and Productivity for more details.

Net Income

Net income is one of the definitions of income. Gross income and net income are unrelated. When operating costs and cost of goods sold have been deducted, the bottom of the income statement displays net income. Total company sales less total company expenses equal net income. As you can see, the concept of net income differs significantly from the revenue definition of income.

Instead of referring to revenues, the general term "income" is most frequently used to describe net income. Exercise caution when reading instances or seeing issues that mention a company's revenue. It would help if you examined the question to determine the definition of income that is being used. The net income definition will most frequently be applied.

How Is Income Calculated?

The calculation of income differs because income is defined differently in various situations, such as taxation, financial accounting, or economic study. Your tax burden for a specific tax year is calculated using the portion of your gross income known as "taxable income". Adjusted gross income (AGI), less allowed standard or itemized deductions, can be used to describe it broadly.

Taxable income includes investments, other unearned income sources, wages, salaries, bonuses, and gratuities. Your taxable income is your gross income from all sources, less certain deductions, like costs, allowances, and reliefs. This can be expressed using the formula:

Income = GI - D

Where GI = Gross Income, D = Deduction

Your total income is calculated together with the income of your spouse or civil partner. To calculate your taxable income, you must add all income received, such as dividends and interest on deposits, to the gross amounts.

Business Income: GAAP Income

Most businesses, including all publicly traded firms, use generally accepted accounting principles (GAAP), or standard financial accounting techniques and practices, to calculate their revenue and worth. Public businesses must prepare and submit audited financial accounts by these regulations. The success of companies in the same or various sectors is compared by investors using the financial accounts of businesses as a benchmark.

The kinds of deviations from public policy that are reflected in the tax law are not taken into account by GAAP computations. The two platforms use different timing criteria to recognize income and expenditures. The outcomes of tax accounting frequently paint a picture of business income and value far removed from economic reality compared to the snapshot of income and business value calculated using GAAP.

Business income is a sort of earned income classified as regular income for tax purposes. It encompasses all income generated by an entity's operations. It is a company's net profit or loss, calculated by deducting all of its operational expenses from all its revenue from all sources.

Types of Income

1. Earned Income

Earned money means just what it says on the tin: It's money you make by working, whether it's for a company you own, for another person, or yourself. Because you actively provide a job for it, it is also known as "active revenue." If an organization employs you, whether a small business or a big conglomerate, your boss might give you an hourly salary based on the number of hours you put in. Or you might receive a salary from your boss, a set sum of money paid to do a specific task. Although salaries can be received weekly, biweekly, or monthly, they are frequently stated as yearly amounts.

Bonuses and overtime compensation may also be considered earned revenue. For instance, waiters at restaurants and cab drivers both receive gratuities. In addition, fees are available to sales professionals. Gigs are one more potential source of money. Consider gig employment if you want to be independent, self-employed, or work a part-time position. These side tasks frequently consist of one-off, impermanent positions that can be performed whenever necessary. One good illustration is musicians. Likewise, meal delivery workers, freelance authors, and babysitters.

2. Passive Income

Do you want to earn cash while you sleep? Making money is feasible without actively working for it. It is therefore regarded as unearned or passive revenue. Some examples of passive revenue are income from rentals, royalties, and limited partnerships.

Do you possess anything that others might want to use? A second home or even a spare bedroom in one's own home may be rented out or leased, and the revenue from doing so is counted as rental income. Another potential source of monthly revenue is the leasing of a commercial building. Vehicles and tools can be leased by businesses profitably as well. Have you penned a novel or a song? Created something new? You might receive profits if you create something original through design, construction, or other means.

Someone who makes personal use of your work or other property may be required to pay royalties. They can pay by the object or the amount of time. For instance, a limited partnership might be created if you lend a friend money so they can start a craft brewery in return for a portion of their earnings. Those earnings could be considered passive income if you don't labour at the brewery. Alimony, child support, unemployment benefits, Social Security, and worker's compensation are additional instances of passive income.

3. Portfolio Income

Your financial possessions are gathered in a financial inventory. Interest, earnings, and investment capital gains can all be included in a portfolio's or investment's revenue. You might receive income from your bank or credit union if you put money into one of their accounts. For instance, checking, savings, money market, and certificates of deposit (also known as CDs) all allow you to make income. You may earn different amounts of money in interest.

You could also make money by investing in equities, bonds, and investment funds. When you purchase bonds, you are lending money to a business or the government in return for interest payments. When you invest in a company's shares, you become a shareholder and earn some of the earnings. The same is true of mutual funds, which combine investor funds to create and handle investments.

Dividends can be compared to the return on your assets. A profitable business can distribute a part of its earnings to its stockholders. Companies frequently distribute rewards in currency. However, you might also get more securities or other investments, like real estate. The difference you make when you trade something for more than you spent for it is known as your capital gain. When you sell a stock or cash out a pension fund whose worth has grown since you purchased it, you can profit with financial investments.

Is There a Standard Definition of Income?

Depending on the situation in which the word is used, income has a different definition. For instance, the tax code uses "gross income," which refers to all kinds of revenue, and "taxable income," which is gross income less certain deductions and other adjustments. On the other hand, the generally accepted accounting principles (GAAP) standard for financial accounting refers to the total sum of all prices for goods and services as "revenue," which is then reduced by expenditures to arrive at net income. Additionally, how income is calculated will differ based on the context-such as a person, a household, a business, a country, etc.

Which Categories of Income Are Tax-Exempt?

Several types of income are exempt from income taxation under federal, state, and municipal tax rules. Federal income tax is typically not applied to interest on bonds issued by state and municipal governments. Interest paid on a few narrow types of federal agency debt is also exempt under federal law. Interest on U.S. Treasury bonds is exempt from state tax regulations, and some states similarly exempt interest on state and local bonds. Also, Roth 401(k) and Roth Individual Retirement Account (IRA) distributions are tax-free. Except for revenue from unrelated trades or enterprises, charities and other tax-exempt organizations do not have to pay taxes on their income.

Key Takeaways

• The quantity of money, property, and other value exchanges obtained over a predetermined time in return for services or goods is usually called "income."
• Income is defined following the setting in which the idea is used; there is no singular, universal definition.
• One is left with taxable income by subtracting the limitations, allowances, and deductions permitted by the tax code from a person or organization's yearly total or cumulative income.
• The yearly financial accounts of companies, which are produced in line with generally recognized accounting standards, are the primary focus of financial authorities, businesses, and investors (GAAP).

Conclusion

One of the most fundamental indicators of economic activity is income. It calculates the total increase in revenues that people or businesses have as a consequence of working or conducting business. In terms of public policy, the majority of taxes are based on wealth. As previously said, we discovered the categories and the criteria for each. We also discussed the advantages and disadvantages and how important it is for the economy and the populace to have a reliable source of earned money.