Income refers to the earnings you receive in exchange for work, services, or selling goods. The government taxes most income. Yet, different types of earnings have their own tax rules. Most income is taxable, but some exceptions apply based on the source and laws.
What is income?
Income includes any money earned from work or investments. It includes wages from work, as well as returns from capital such as dividends or interest. Income falls into different categories. These include earned and unearned income, as well as gross and net income. Each type has unique financial effects.
Key Takeaways
- Income refers to the earnings or benefits gained through employment or investments. It represents financial returns from labor, business activities, or capital growth.
- Earnings from a job, dividends, and interest from investments are all considered income.
- Gross income is your total earnings before deductions. Net income is what you get after taxes and other withholdings.
- Earned income is what you make from working. Unearned income is passive, like money you get from investments.
- The federal government and certain U.S. states tax income at varying rates.
How Income Works
Income refers to any earnings gained through work, business transactions, or investments. While it is often received as money, it can take other forms. Wages from employment, dividends, and interest from investments are all considered income.
The federal government and most states impose taxes on various types of income. The IRS says income includes money, property, goods, and services. Most types are taxable, even if you donโt use or receive them right away.
Income isn’t about job wages. It also includes money from investments and retirement plans. Additionally, non-cash benefits like gifts for services count as income too. In most cases, you must report it to the IRS, and it is subject to taxation.
Types of Income
Gross Income vs. Net Income
Your employer might offer a weekly salary of $2,000. Yet, your actual paycheck will be less. This is because of deductions for taxes, retirement contributions, and insurance premiums.
Gross income is what you earn before any deductions. Net income is what remains after taxes and other withholdings.
Unearned Income vs. Earned Income
Unearned income comes from investments rather than active work. It includes earnings like dividends, interest, capital gains, and retirement distributions. Taxable benefits include some Social Security payments and unemployment compensation.
Earned income is compensation received for work or services. When starting a new job, employees fill out Form W-4. This form helps decide tax withholdings. It takes into account things like marital status and dependents. Employers use this info to take out the right taxes and send them to the government.
Ordinary Income vs. Capital Gains
Ordinary income includes earned and unearned money. Capital gains come from selling assets, such as stocks or real estate.
If you bought land for $100,000 and later sold it for $200,000, the $100,000 profit is a capital gain. Capital gains are subject to a different tax treatment compared to ordinary income. The rates can be lower based on your total earnings. These rates usually rise as income levels increase.
Capital gains tax rates are usually 0%, 15%, or 20%. Yet, some assets, like collectibles and small business stock, face a 28% tax starting in 2025. Losses from investments can offset gains under specific rules. In contrast, ordinary income tax rates range from 10% to 37%.
If someone holds an asset for more than a year before selling it, capital gains tax rates apply. If someone sells it within a year, they will tax it as ordinary income. Even a single extra day can make a difference in the tax rate.
How the government taxes income
The Internal Revenue Code sorts income into types, each with its own tax rules. In the U.S., both the payer and recipient must report income. They do this using W-2 or 1099 forms. The sender sends these forms to the IRS and, if needed, to state authorities.
Even if you live and work abroad, U.S. citizens must still file a tax return and pay taxes on their income. Yet, the IRC allows an exclusion on foreign earnings, up to $126,500 for 2024 and $130,000 for 2025.
Some states, like Alaska, Florida, and Texas, donโt tax income. Others include Nevada, South Dakota, Tennessee, and Wyoming. New Hampshire taxes only dividends and interest. In contrast, Washington taxes capital gains. Recipients are still responsible for any applicable taxes on their earnings.
FICA
Starting in 2025, the government will take a 6.2% Social Security tax from earnings up to $176,100. Employers will match this contribution. Medicare follows a similar structure, with both employees and employers contributing 1.45%.
Self-employed people must pay both the employee and employer taxes. They see both roles. The individual must consent to the organization making these payments every quarter.
If taxpayers earn more than specific income limits, they must pay a 3.8% tax on their net investment income. The thresholds vary from $125,000 to $250,000, depending on filing status. Yet, the tax applies to net investment income if it is above the thresholds.
Gift and Estate Taxes
Gift values usually face taxation. Yet, the donor is the one who pays the federal gift tax, not the recipient. Connecticut is the only state that imposes a state-level gift tax.
The estate tax applies when beneficiaries receive a deceased personโs assets. As of 2025, individuals can transfer up to $13.99 million tax-free under the federal exemption. Only 12 states and Washington, D.C. impose their estate taxes.
Tax Breaks on Ordinary Income
The IRS provides tax deductions and credits under the Internal Revenue Code. These help lower your taxable income or the total tax you owe.
Tax credits reduce the amount you owe and can be refundable, meaning they may pay back any excess to you. Deductions lower taxable income, with tax applied only to the remaining balance. The standard deduction, which varies by filing status, ranges from $15,000 to $30,000 for 2025.
You can itemize deductions. This means you can subtract eligible expenses. These expenses include mortgage interest, state taxes, property taxes, and charitable donations. You can’t claim both itemized deductions and the standard deduction. You have to choose one.
FAQs
What is the meaning of income?
Income refers to any earnings received from work, business activities, or investments. It includes wages, profits, interest, and dividends.
What is the meaning of income in taxation?
In taxation, income represents any money or benefits earned that may be subject to taxes. This includes salaries, rental earnings, investment returns, and even certain gifts or inheritances.
What are the categories of income?
Income is generally divided into earned and unearned income. Earned income is money from wages, salaries, and self-employment. Unearned income includes things like dividends, interest, rental income, and capital gains.
Does income include tax?
Income itself does not include tax, but it is often subject to taxation. Gross income is the total money earned before any deductions. Net income is what you keep after taxes and other deductions.
Does income include bonuses and commissions?
Yes, bonuses and commissions are considered part of earned income. They are taxable and must be reported along with regular wages.
Is income from investments taxable?
Yes, most investment income, including dividends, interest, and capital gains, is taxable. Yet, certain investments, like municipal bonds, may offer tax-exempt income.
How does income affect tax brackets?
Your tax bracket depends on your total taxable income. This bracket affects the percentage of tax you owe. Higher income levels generally result in higher tax rates.
Conclusion
Knowing about income and its types is key to managing finances and taxes well. Income, from jobs, businesses, or investments, is key in figuring out tax liability. Understanding how income is taxed is important. It includes knowing the difference between gross and net income. This knowledge helps people make smart financial choices. Taxpayers can boost their earnings by knowing about tax deductions, credits, and exemptions. This way, they stay compliant with tax laws.
