What Is Section 61 and How Does It Define Gross Income?

The U.S. tax system defines income broadly to determine what individuals and businesses must report and pay taxes on. Section 61 of the Internal Revenue Code (IRC) establishes this definition, forming the basis for calculating taxable earnings.

Understanding what qualifies as gross income helps taxpayers comply with tax laws and avoid issues with the IRS. While many forms of income are taxable, specific exclusions reduce tax liability.

Broad Types of Taxable Income

The Internal Revenue Code categorizes income in various ways, ensuring earnings from different sources are properly reported. While Section 61 provides a comprehensive definition, tax treatment varies based on income type and applicable laws.

Compensation for Services

Wages, salaries, bonuses, and commissions are all taxable. Employees have federal income tax, Social Security, and Medicare taxes withheld from paychecks, while independent contractors report earnings on Form 1099-NEC and pay self-employment taxes.

Severance pay, cash tips, and employer-provided gift cards are also taxable. Employees must report tips exceeding $20 per month. Non-qualified stock options (NSOs) are taxed as ordinary income when exercised, while incentive stock options (ISOs) may receive favorable tax treatment if specific conditions are met.

Interest and Dividends

Interest income from savings accounts, certificates of deposit (CDs), corporate bonds, and Treasury securities is taxable and reported on Form 1099-INT. Interest from municipal bonds is generally exempt from federal taxes but may be subject to state taxes.

Dividends, which are corporate profit distributions, are classified as qualified or non-qualified. Qualified dividends are taxed at lower capital gains rates (0%, 15%, or 20%, depending on income), while non-qualified dividends are taxed as ordinary income. Dividend reinvestment does not exempt dividends from taxation; they must still be reported in the year received.

Rental Proceeds

Income from leasing residential or commercial property is taxable and reported on Schedule E. This includes rent payments, prepaid rent, and retained security deposits. If a tenant provides services instead of cash rent—such as maintenance work in exchange for reduced rent—the fair market value of those services must be included in gross income.

Deductions can offset rental income, including mortgage interest, depreciation, property taxes, and maintenance expenses. Passive rental activity—where the taxpayer does not materially participate—limits deductible losses. Short-term rental income, such as from Airbnb or Vrbo, may be subject to self-employment tax if the owner provides services beyond basic lodging.

Self-Employment Earnings

Sole proprietors, freelancers, and independent contractors report income on Schedule C and pay self-employment tax, which covers Social Security and Medicare contributions at a combined rate of 15.3%. Half of this amount is deductible when calculating adjusted gross income.

Self-employed individuals must make estimated tax payments quarterly if they expect to owe at least $1,000 for the year. Business-related deductions, such as home office expenses, vehicle mileage, and advertising costs, can reduce taxable income. The home office deduction requires exclusive business use of the workspace and is calculated using either the simplified method ($5 per square foot, up to 300 square feet) or actual expenses.

Income from gig economy work, such as Uber driving or Etsy sales, is also classified as self-employment earnings. Platforms processing more than $600 in payments to an individual must issue Form 1099-K. Failure to report this income can result in penalties and interest charges.

Gains from Property Dispositions

When an individual or business sells, exchanges, or otherwise disposes of property, any financial gain is taxable. The taxable amount is determined by subtracting the property’s adjusted basis—typically the original purchase price plus improvements and certain costs—from the sale price or fair market value received.

The tax treatment depends on the asset type and holding period. Capital assets, such as stocks, real estate, and collectibles, are subject to capital gains tax. If held for more than one year, gains are taxed at long-term capital gains rates (0%, 15%, or 20%). Assets held for one year or less are taxed at ordinary income rates.

Homeowners selling a primary residence may exclude up to $250,000 of gain ($500,000 for married couples filing jointly) if they have lived in and owned the home for at least two of the past five years. This exclusion does not apply to rental or investment properties, where gains are fully taxable unless reinvested through a like-kind exchange. Like-kind exchanges apply only to real property and require a replacement property to be identified within 45 days and acquired within 180 days of the sale.

Depreciation recapture applies to rental properties and business assets. When an owner claims depreciation deductions, the IRS requires that portion of the gain to be taxed at a maximum rate of 25% upon sale rather than the lower capital gains rates. This can significantly impact tax liability, particularly for long-held properties with substantial depreciation deductions.

Fringe Benefits

Employers often provide benefits beyond wages, some of which are taxable.

Company-provided vehicles are a common taxable benefit. If an employee uses a company car for personal trips, the value of that usage must be included in gross income. Employers can calculate this amount using the annual lease value method or the cents-per-mile valuation, set at 67 cents per mile for 2024. Employer-paid commuting benefits, such as transit passes or parking allowances, are taxable if they exceed the monthly exclusion limit of $315.

Stock-based compensation, such as restricted stock units (RSUs), is taxed when the shares vest. The fair market value of the shares on the vesting date is treated as ordinary income. Employers typically withhold taxes at a flat supplemental rate of 22% for amounts up to $1 million, but employees may owe additional taxes depending on overall earnings.

Tuition assistance programs can also have tax implications. Employers may provide up to $5,250 per year in tax-free educational assistance. Any amount exceeding this threshold is taxable unless it qualifies as a working condition benefit, meaning the education maintains or improves job-related skills.

Bartered Transactions

Exchanging goods or services without cash is a taxable event. The IRS requires participants to report the fair market value of what they receive as income. This applies to individuals, businesses, and organized barter networks.

Businesses frequently engage in barter to conserve cash flow, such as a marketing firm providing advertising services in return for accounting assistance. Both parties must determine the fair value of the exchanged services and report it on their tax returns. Businesses involved in bartering through an exchange must file Form 1099-B. Failure to report barter income can result in penalties and interest.

Common Exclusions and Non-Taxable Items

While Section 61 broadly defines gross income, certain types of earnings are excluded under the Internal Revenue Code, reducing taxable income.

Gifts and inheritances are among the most notable exclusions. Gifts are not taxable to the recipient, though the donor may owe gift tax if the amount exceeds the annual exclusion limit of $18,000 per recipient in 2024. Inheritances are not taxed at the federal level, though estate taxes may apply if the total estate value exceeds $13.61 million in 2024. However, income generated from inherited assets, such as rental income, is taxable.

Life insurance proceeds paid to beneficiaries upon the policyholder’s death are excluded. However, if a policy is sold to a third party before the insured’s death, the proceeds may become taxable. Employer-provided health insurance premiums are also excluded, as are reimbursements from health savings accounts (HSAs) and flexible spending accounts (FSAs) when used for qualified medical expenses.