What Is Income?
Let me tell you directly: income is basically anything you get in return for your work, sales, or investments, and yes, most of it is taxable, though there are a few exceptions we'll get into.
When I say income, I'm talking about any compensation or benefit you receive for the work you do or the capital you've invested. This could be the paycheck from your job or the returns from your investments. We can break it down into categories like gross versus net income, and earned versus unearned income, which I'll explain as we go.
How Income Works
Income is straightforward—it's the compensation you get for services, selling goods, or putting your money to work through investments. Usually, it's money, but it can be other things too. Your employer's paycheck counts, as do dividends and interest from investments.
Governments, especially the federal one and most states, take a cut through taxes. The IRS defines income as money, property, goods, or services, meaning most of it is taxable, even if you don't use it immediately or if it's paid to someone else for you.
You might just think of your regular paycheck when you hear 'income,' but it includes more—like investment distributions, retirement payouts, or even that bottle of wine you got for dog-walking. In most cases, report it to the IRS and pay taxes on it.
Types of Income
Let's start with gross versus net income. If your employer pays you $2,000 a week, they won't hand you that full amount—they deduct for taxes, retirement contributions, insurance, and so on. That initial $2,000 is your gross income; what's left is your net income.
Next, unearned versus earned income. Unearned income comes from investments—you didn't actively work for it, though you might have earned the money to invest. Think dividends, interest, capital gains, retirement distributions, or even taxable Social Security or unemployment benefits.
Earned income is what you get for actually working or providing a service. When you start a job, you fill out a W-4 with details like marital status and dependents, which determines how much tax your employer withholds.
Then there's ordinary income versus capital gains. Ordinary income covers both earned and unearned types. Capital gains come from selling assets like real estate or stocks. For example, if you buy land for $100,000 and sell for $200,000, that's a $100,000 gain, taxed at special rates—often 0%, 15%, or 20%, depending on your income and how long you held the asset. Hold it over a year for those lower rates; otherwise, it's taxed as ordinary income. You can offset gains with losses, but there are rules.
How Income Is Taxed
The Internal Revenue Code categorizes income types, each with its own tax rules. In the U.S., payers and recipients report via W-2s and 1099s to the IRS and states if needed. Even if you're a U.S. citizen working abroad, you still file and pay, though some foreign income can be excluded.
Not all states tax income—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Wyoming don't; New Hampshire taxes only dividends and interest, Washington only capital gains.
On FICA: Social Security takes 6.2% from your gross income, matched by your employer; Medicare is 1.45% each. Self-employed pay both shares quarterly. High earners might face additional net investment income tax.
Gifts are taxable, but the donor pays federal gift tax; only Connecticut has a state version. Estate taxes apply when transferring property after death to beneficiaries.
Tax Breaks on Ordinary Income
The IRS offers deductions and credits to ease the burden. Credits subtract directly from your tax bill, and some are refundable—meaning you get money back if it exceeds what you owe. Deductions reduce your taxable income.
You can take the standard deduction or itemize expenses like mortgage interest, state taxes, property taxes, or charitable donations. It's one or the other, not both.
The Bottom Line
Income is essentially anything you receive from work, investments, or selling property. More income means more taxes in the U.S., and it directly affects your standard of living and quality of life.
Key Takeaways
- Income is compensation or benefits from work or investments.
- It includes employer pay, dividends, and interest.
- Gross income is before deductions; net is after.
- Earned income requires work; unearned is passive like investments.
- U.S. federal and some state governments tax income at varying rates.
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