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Income

The amount of money that is earned by an individual/company for providing a service or product

What is Income?

Income refers to the amount of money that is earned by an individual for providing a service or as an exchange for providing a product. The income earned by an individual is used to fund their day-to-day expenditures, as well as fund investments. Some of the common types of income include salaries, revenue from self-employment, commissions, and bonuses. For companies, net income earned during a specific period is obtained by summing all the revenues earned by the business minus taxes and business expenses, this is an important metric for business performance. Other types of income include social security, pensions, stock option plans, and 401k, which are typically earned by retired persons.

 

Income

 

Taxable Income

Taxable income is the amount used to calculate how much taxes you owe the government. All the salaries, wages, dividends, interest received, pension, and capital gains earned during the financial year are taken into account when calculating taxable income.

Income tax laws varies in every country, state and province. It is important to understand your tax obligations in accordance to local law.

 

Filing Taxes

For employed individuals, payroll is set to automatically deduct all the taxes such as social security, federal, and state taxes. However, it is different for self-employed individuals who must pay taxes directly to the US Internal Revenue Service (IRS). A self-employed person must calculate the amount of taxes they owe to the government, and make a lump sum payment by tax payment deadline in April or make quarterly payments.

Self-employed individuals with employees are required to notify the employees who they worked with during the year to file taxes if the company did not withhold their income taxes. In a situation where an employee has claimed an exemption from withholding, the employer is not required to notify them formally.

 

Tax-Exempt Income

Tax-exempt income is money earned by an individual or company that is not subject to federal or state taxes, as determined by the IRS. The following are examples of tax-exempt benefits:

  • Interest from U.S. Treasury bonds (exempt from state and federal taxes)
  • Employer-sponsored supplemental disability insurance purchased with after-tax dollars
  • Distributions from Roth 401(K) plans
  • Interest on municipal bonds (exempt from state and federal taxes)
  • Capital losses from sold assets (exempt up to $3,000 per year)

 

Gross vs. Net Income

Gross income is revenue before any taxes and deductions have been deducted. It sums up the revenue from all sources, including non-cash items such as services and property. For most salaried individuals, the gross income is the total salary before tax and deductions. Some individuals may have additional sources of income like dividends, capital gains, rent received, tips, etc. that are added to the gross income.

For a company, gross income is calculated by summing all revenues earned from the sale of products and services minus the cost of goods sold. Both lenders and landlords consider the gross income when determining whether an individual or company will be able to honor their obligations.

On the other hand, the net income of an individual is the gross income minus taxes and deductions. It is the amount of money individuals take home, and that is available to spend on day-to-day expenditures. It is indicated in an employee’s paycheck.

The net income for a company is calculated by summing all the business revenue, minus the cost of goods sold, business expenses, operating expense, depreciation, interest expense, and tax. The net income of a company is contained at the bottom of the profit and loss (P&L) statement. It is the profit attributable to shareholders, and it is used to calculate earnings per share (EPS).

 

Disposable vs. Discretionary Income

Disposable income is the amount of money that is available for spending after deducting taxes. It is spent on necessities such as food, clothing, housing, transport. For example, assume that an individual earned $150,000 during the last financial year and the rate for their tax bracket is 30%. It means that their disposable income will be $150,000* (1 – 0.3) = $105,000. Where 0.3 is the tax rate.

The disposable income of the citizens of a country is constantly monitored by different government agencies as a key economic indicator, and it is a good proxy for the overall health of the economy. Once all the payments for necessities have been deducted from disposable income, the resulting value is equal to the discretionary income.

Discretionary income is the amount of money earned that is available for an individual to save or invest, after paying for all the necessities. This is money that can be spent as the user chooses, either on vacations, movies, cable television, consumer electronics, luxury goods or other non-essential goods or services. For example, if an individual earns $5,000 per month after taxes, and spends $3,500 in paying for necessities, the remaining $1,500 is the discretionary income.

 

Related Readings

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