Income: Definition, Meaning & Overview

KEY TAKEAWAYS

• The amount of money, property, and other transfers of value obtained over a predetermined period of time in return for services or goods are often referred to as “income.”
• Income is defined in accordance with the context in which the word is employed; there is no single, universal definition.
• By subtracting the exclusions, exemptions, and deductions permitted by the tax code from the annual total or gross income of an individual or corporation, one is left with taxable income.
• The annual financial statements of enterprises, which are prepared in line with generally accepted accounting principles (GAAP), are the primary focus of financial authorities, firms, and investors.

What Is Income?

Income refers to the cash received by an individual or organization in return for their services or goods. Income may have a variety of definitions. This is depending on the context—such as taxation, financial accounting, or economic analysis.

For the majority of people, their total earnings include their wages and salaries, investment returns, pension payments, and other receipts. For businesses, income refers to the money made from selling goods and services as well as any interest or dividends paid on the company’s cash holdings and reserves.

Different definitions and methods of calculating income are used by economists. Their definition of income will be in line with the goal of their research, regardless of whether it involves earnings, savings, consumption, production, public finance, capital investment, or other relevant issues and subtopics. Although a macroeconomic measure of income is important for sociological and policy research, people tend to be more concerned with their own personal and business income.

Types of Income

Income can be split into three separate categories. They are as follows:

1. Ordinary Income

The tax code in the United States distinguishes between capital investments and regular income. Earnings, interest, recurring dividends, rental income, payouts from pensions or retirement accounts, and Social Security benefits are all considered to be part of ordinary income. In 2022, the tax rate on ordinary income ranged from 10% to 37%.

A further 3.8% net investment income tax is applied to taxpayers whose net investment income or the amount of your modified adjusted gross income (MAGI) whichever is less exceeds certain levels.

2. Tax-Exempt Income

Interest received on some bonds issued by public bodies is recognized as income exempt from taxation. State and municipal taxes are not levied on the interest received on Treasury securities and federal bonds.

Federal taxation does not typically apply to interest on bonds issued by state and local governments. Municipal private activity bonds are liable to the federal alternative minimum tax but not the ordinary federal income tax. Some states and municipal governments likewise don’t tax the interest on local and state bonds.

3. Capital Gains Income

Gains from the sale of assets that have increased in value are known as capital gains. The capital gains tax rates in the US is 15% if your taxable income is:

• More than $41,675 but less than or equal to $459,750 for single; 
• More than $83,350 but less than or equal to $517,200 for married and filing jointly or qualifying surviving spouse; 
• More than $55,800 but less than or equal to $488,500 for head of household or more than $41,675 but less than or equal to $258,600 for married filing separately.

However, a net capital gain tax rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate. There are a few other exceptions where capital gains may be taxed at rates greater than 20%, like personal homes and investments in real estate, stocks, bonds, and other financial products.

Qualified dividends, or those paid with regard to US and specific foreign corporate stock holdings that satisfy statutory holding-period criteria, are also subject to capital gains rates of taxation.

How Is Income Calculated?

Because income is defined differently in different contexts—such as taxation, financial accounting, or economic analysis, the calculation of Income varies. 

The portion of your gross income known as “taxable income” is used to determine your tax liability for a certain tax year. It can be roughly defined as adjusted gross income (AGI) less permitted standard or itemized deductions. 

Wages, salaries, bonuses, and gratuities are all considered forms of taxable income, as are investment income and different unearned income streams.

For tax purposes, your gross income from all sources less specific deductions, such as costs, allowances, and reliefs, is your taxable income. This can be written in the following formula:

The income of your spouse or civil partner is included in your total income and are being assessed jointly.

You must use the gross amounts to determine your taxable income by including any types of income received, for example dividends or deposit interest income.

What Is Business Income?

For tax reasons, business income is categorized as regular income and is a type of earned income. It includes all earnings derived from an entity’s activities. It is a company’s net profit or loss, which is determined by subtracting all of its revenue from all sources from all of its operating expenses.

Which Categories of Income Are Tax-Exempt?

Certain 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, very narrow types of federal agency debt is also exempt under federal law.

Interest on US Treasury bonds is exempt from state tax regulations, and some states similarly exempt interest on state and local bonds. Additionally, 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.

Summary

One of the most fundamental indicators of economic activity is income. It calculates the net increase in revenues that people or businesses have as a result of working or conducting business. In terms of public policy, the majority of taxation is based on income.

A business should report its total income to the Internal Revenue Service (IRS) via its annual tax return. 

Written by Jami Gong, MPAcc, CPA

Jami Gong is a Chartered Professional Account and Financial System Consultant. She holds a Masters Degree in Professional Accounting from the University of New South Wales. Her areas of expertise include accounting system and enterprise resource planning implementations, as well as accounting business process improvement and workflow design. Jami has collaborated with clients large and small in the technology, financial, and post-secondary fields.

Written by Jami Gong, MPAcc, CPA

Jami Gong is a Chartered Professional Account and Financial System Consultant. She holds a Masters Degree in Professional Accounting from the University of New South Wales. Her areas of expertise include accounting system and enterprise resource planning implementations, as well as accounting business process improvement and workflow design. Jami has collaborated with clients large and small in the technology, financial, and post-secondary fields.