What Is an Item of Income for Federal Tax Purposes?

The concept of income for federal tax purposes is expansive. The Internal Revenue Service (IRS) operates on the principle that all income is taxable unless a specific law states otherwise. Understanding what the government considers an “item of income” is the first step for any individual to accurately determine their annual tax obligations. This includes recognizing the value of direct payments, goods, and services received.

The Foundation of Gross Income

The Internal Revenue Code defines gross income as “all income from whatever source derived.” This broad language means that whether income comes as money, property, or services, it is subject to tax. The law focuses on the economic benefit received by the individual.

Two principles govern when income must be recognized: constructive receipt and the claim of right doctrine. Constructive receipt means income is taxable in the year it is made available to you without restriction, not when you possess it. For instance, if your employer makes your final December paycheck available on the last day of the year, you have constructively received that income, even if you wait until January to collect it.

The claim of right doctrine states that if you receive income with an unrestricted right to its use, it must be included in your income for the year of receipt. This holds true even if you might have to return the money in a future year. If you must repay it, you would take a deduction or credit in the year of repayment.

Common Examples of Taxable Income

For most individuals, the most familiar item of income is compensation for services rendered. This category includes wages, salaries, tips, commissions, and bonuses paid by an employer. All forms of compensation are considered taxable in the year they are received.

Income from a business or farm is another significant category. If you are self-employed or operate a farming business, your net profit is considered taxable income. This is calculated from your gross income less the ordinary and necessary expenses of the business.

Many taxpayers also receive income from their investments. Interest earned on bank accounts or corporate bonds is a common form of taxable income. Similarly, dividends paid out by corporations to their shareholders are considered income and are taxable in the year they are paid or credited to your account.

Receiving payments for the use of property you own, such as a house or an apartment, generates rental income. The total amount of rent received is included in gross income, though you can offset this with certain rental expenses. When you sell an asset like stocks or real estate for more than your original cost, the resulting profit is a taxable gain.

A source of income that can be a surprise is unemployment compensation. Payments received from a state unemployment system are a replacement for lost wages. As such, the full amount of unemployment benefits received is subject to federal income tax.

Frequently Overlooked Income Sources

Beyond typical wages and investment returns, several other types of economic benefits count as income.

• Bartering, the exchange of property or services without using money, creates taxable income for both parties. The income recognized is the fair market value of the goods or services you receive.
• If a lender forgives or cancels a debt you owe, the amount of the canceled debt is considered taxable income. There are exceptions, such as for bankruptcy or insolvency.
• Prizes, awards, and gambling winnings are fully taxable. This includes lottery winnings, casino payouts, and the fair market value of a car won on a game show.
• A portion of your Social Security benefits may be taxable, depending on your total income. The calculation is based on your filing status and combined income.
• For divorce or separation agreements executed before January 1, 2019, alimony received is taxable income to the recipient. For agreements made after 2018, such payments are not taxable.

Items Excluded From Income

While the definition of income is broad, Congress has specifically excluded certain items from taxation.

• The recipient of a gift or an amount from a deceased person’s estate does not include that value in their gross income. Any potential gift or estate tax is the responsibility of the giver or the estate.
• Payments received for child support are not considered income for the recipient. The IRS views these payments as a fulfillment of a parental support obligation.
• Proceeds from a life insurance policy paid to a beneficiary upon the death of the insured are not taxable income. This exclusion applies to the death benefit, though any interest earned on the proceeds may be taxable.
• Certain scholarships and fellowship grants are excluded from income. The funds must be used for tuition, fees, books, and required equipment at an eligible educational institution.
• Many government-provided social benefits are not taxable. This includes welfare payments, which are excluded from the recipient’s gross income because they promote the general welfare.