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As you are getting ready to file your tax return, it is very important that you have a better idea about what kind of income is taxable and needs to be reported to the IRS.
In the United States, taxes based on income are imposed at the federal, most state, and some local levels, which, of course, is common knowledge. The tax systems within each jurisdiction may define taxable income separately. The definition of taxable income for federal purposes is used by many, but far from all states.
At the federal level, the IRS defines income as the sum of all the wages, salaries, profits, interest payments, rents and other forms of earnings received in a given period of time.
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Gross income means all income from whatever source derived, which can be received in the form of money, property, or services, and is taxable unless it is specifically exempted by law. Taxable income is gross income less exemptions, deductions, and personal exemptions.
Nontaxable income may be either because that income is considered as incentive or supported by the government, it was already taxed at origins, or just falls below a certain taxable level.
Income that is taxable must be reported on your return and is obviously subject to tax. Income that is nontaxable may have to be shown on your tax return even if it isn’t taxable.
Let’s elaborate a little on taxable income and some of the less familiar terms used in connection with it.
You are generally taxed on income that is available to you, regardless of whether it is actually in your possession.
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- A valid check that you received or that was made available to you before the end of the tax year is considered income constructively received in that year, even if you don’t cash the check or deposit it to your account until the next year. For example, if the postal service tries to deliver a check to you on the last day of the tax year but you aren’t at home to receive it, you must include the amount in your income for that tax year. If the check was mailed so that it couldn’t possibly reach you until after the end of the tax year, and you otherwise couldn’t get the funds before the end of the year, you include the amount in your income for the next tax year.
Income received by an agent for you is income you constructively received in the year the agent received it. If you agree by contract that a third party is to receive income for you, you must include the amount in your income when the third party receives it. This is called assignment of income. For instance, you and your employer agree that part of your salary is to be paid directly to one of your creditors. You must include that amount in your income when your creditor receives it.
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In most cases, prepaid income, such as compensation for future services, is included in your income in the year you receive it. However, if you use an accrual method of accounting, you can defer prepaid income you receive for services to be performed before the end of the next tax year. In this case, you include the payment in your income as you earn it by performing the services.
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Employee compensation. In most cases, 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.
Your employer's contributions to a qualified retirement plan for you aren't included in income at the time contributed. (Your employer can tell you whether your retirement plan is qualified.) However, the cost of life insurance coverage included in the plan may have to be included. |
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In most cases, the cost of up to $50,000 of group-term life insurance coverage provided to you by your employer (or former employer) isn’t included in your income. However, you must include in income the cost of employer-provided insurance that is more than the cost of $50,000 of coverage reduced by any amount you pay toward the purchase of the insurance.
Miscellaneous compensation may include advance commissions and other earnings; allowances and reimbursements; bonuses and awards; sick pay; accrued leave payment, and more. |
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| Fringe benefits received in connection with the performance of your services are included in your income as compensation unless you pay fair market value for them or they are specifically excluded by law. Abstaining from the performance of services (for example, under a covenant not to compete) is treated as the performance of services for purposes of these rules. |
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If a fringe benefit is included in your income, the amount included is generally its value determined under the general valuation rule or under the special valuation rules.
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the employer to account for it, the value isn’t included in your income.
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Stock Options. If you receive an option to buy or sell stock or other property as payment for your services, you may have income when you receive the option (the grant), when you exercise the option (use it to buy or sell the stock or other property), or when you sell or otherwise dispose of the option or property acquired through exercise of the option. The timing, type, and amount of income inclusion depend on whether you receive a non-statutory stock option or a statutory stock option. Your employer can tell you which kind of option you hold.
Special rules apply for certain types of employment: members of the clergy, members of religious orders, people working for foreign employers, military personnel, and volunteers. |
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Business and investment income is, of course, taxable.
If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is in most cases determined by: whether or not the rental activity is a business, and whether or not the rental activity is conducted for profit.
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
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A partnership generally isn't a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items.
In most cases, an S corporation doesn't pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share. You must report your share of these items on your return. In most cases, the items passed through to you will increase or decrease the basis of your S corporation stock as appropriate. |
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You must report as income any amount you receive for personal injury or sickness through an accident or health plan that is paid for by your employer. If both you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income.
If you retired on disability, you must include in income any disability pension you receive under a plan that is paid for by your employer.
Miscellaneous income may include taxable income from: bartering, cancelled debts, interest income received as a result of life insurance proceeds, recoveries, survivor benefits, unemployment compensation, Social Security benefits (may be subject to federal income tax depending on your filing status and other income).
Any other income from whatever source, even income from crimes is taxable and must be reported, as failure to do so is a crime in itself. If you receive a bribe, include it in your income.
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Of course there are still other possible sources of income, taxable or nontaxable, which are not mentioned here; in fact, there may be no complete list anywhere on the internet, unless you are willing to read all through the Federal Tax Law and keep up with all new rules and regulations that come up every year. Nevertheless, many kinds of income are discussed and explained in Publication 525, Taxable and Nontaxable Income.
As we always remind you with each of our newsletters, your best option is to ask for professional help and make sure you’re not paying more than you should in taxes on your taxable income. |
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