Table of Contents
What is income?
Income refers to the money that a person or business regularly receives, typically from employment, investments, or business operations. It is the inflow of economic resources, such as cash, salaries, commissions, or profits. Income measures an individual’s or company’s financial well-being and is critical in determining an individual’s tax liability. Different forms of income, such as earned income, passive income, and capital gains, are taxed differently by the government.
What Is Taxable Income?
Taxable income is the portion of an individual’s income subject to income tax. It is calculated by subtracting allowable tax deductions and exemptions from a person’s total income, including wages, salaries, tips, investments, and self-employment income. The resulting amount is the taxable income used to determine an individual’s tax liability. The amount of taxable income and the tax rate applied to it vary depending on the jurisdiction and the individual’s tax bracket, based on their income level and filing status. Taxable income determines an individual’s tax obligation and is reported on their tax return each year.
The different types of income include:
- Earned income
- Passive income
- Portfolio income
- Business income
- Capital gains
- Retirement income
- Social security income
These are the most common income types, but others may depend on a person’s financial situation.
1. Earned income
Earned income is the money an individual receives as compensation for providing labor or services, either as an employee or self-employed individual. It includes wages, salaries, tips, bonuses, and other forms of compensation received for work performed. It is considered the most common form of income and is used to calculate an individual’s taxable income.
2. Passive income
Passive income is a type of income received without the recipient having to actively participate in generating the income. It is earned from investments, rental properties, and other sources that generate regular payments without needing ongoing effort. Examples of passive income include:
- Rental income.
- Dividends from stocks.
- Interest from savings accounts.
- Royalties from patents or copyrights.
- Income from a business in which the individual is not actively involved.
The critical characteristic of passive income is that it requires little to no ongoing effort to maintain, allowing the recipient to receive income with minimal time or effort.
3. Portfolio income
Portfolio income is generated from investments, such as stocks, bonds, or mutual funds. It is received due to ownership in various financial assets, such as stocks or bonds, that generate interest, dividends, or capital gains. Portfolio income can include interest income from bonds, dividends from stocks, capital gains from the sale of securities, and other investment-related earnings. The goal of portfolio income is to generate a stable and predictable income from investments without the need for active involvement in generating income. Portfolio income is typically considered a form of passive income, as it does not require ongoing effort to maintain.
4. Business income
Business income refers to the revenue generated by a company through its normal business operations. It represents the amount of money a business earns from selling goods or services to its customers. Business income is a crucial component of a company’s financial performance and is used to calculate the company’s profitability and financial health.
5. Capital gains
Capital gains refer to the profit realized from selling a capital asset, such as stocks, bonds, real estate, or mutual funds, for a price higher than the original purchase price. The capital gains tax is a tax on the profit made from the asset’s sale. The amount of tax owed depends on various factors, including the type of asset, the length of time it was held, and the individual’s tax bracket.
6. Retirement income
Retirement income refers to the money received by an individual during their retirement years, typically from sources such as pensions, Social Security, personal savings, and investment portfolios. The goal of retirement planning is to accumulate enough savings and investments to provide a steady income during retirement, allowing individuals to maintain their standard of living without relying on employment income. The specific sources and amount of retirement income vary based on an individual’s circumstances, such as career history, savings habits, and investment strategies.
7. Social security income
Social Security is a federal insurance program in the United States designed to provide income to eligible individuals and families during retirement, disability, or in the event of a worker’s death. Social Security benefits are funded through payroll taxes paid by workers and employers. To be eligible for Social Security, individuals must have earned sufficient credits through their work history and paid into the program. The amount of Social Security income an individual receives is based on their earnings history and the age at which they begin claiming benefits. Social Security is a crucial source of retirement income for many Americans and helps to provide financial security for those who have retired or become disabled.