Business, Legal & Accounting Glossary
Taxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate for that income. Generally, taxable income refers to an individual’s (or corporation’s) gross income, adjusted for various deductions allowable by statute. The main questions put by most individuals in any jurisdiction are “what makes up my taxable income” and what tax rates should be applied such that I can work out my tax liability to the state. For example, suppose within a year, one person earned $100,000 from work, made $50,000 profit from selling stock, and won the lottery for $1,000,000. This person has, prima facie, an income of $1,150,000. However, some of this income may be taxed at a lower rate, or perhaps not taxable at all. In most western countries, 100% of regular salary (above a certain threshold) is taxable and a portion of Capital Gain (ie profit from selling stock or real estate) is taxable.
In the United States, taxable income is defined two different ways in Internal Revenue Code 63. These two definitions of taxable income are based on what type of deduction a taxpayer chooses to take. If a taxpayer elects to take a standard deduction, the taxpayer cannot itemize, and vice versa. In Internal Revenue Code 63(a), taxable income is defined as gross income minus the deductions allowed by this chapter (other than the standard deduction). In Internal Revenue Code 63(b), taxable income is defined as Adjusted Gross Income minus the Standard deduction (or the Itemized deduction) minus the deduction for personal exemptions.
Taxable income = Gross Income – All deductions allowed (other than the standard deduction).
or
Taxable income = Adjusted Gross Income – Standard deduction (or Itemized deduction) – Personal exemptions.
“Income” itself is not defined in the Internal Revenue Code. Gross income is defined in section 61 of the Code, and in the case law interpreting the Code.
Taxable income is all income that is subject to taxation by the Internal Revenue Service (IRS). Although taxable income is the only type of income that is subject to taxation, reporting of non-taxable income may be required by the IRS. Individuals, businesses, charities, non-profits and even government entities have taxable income.
The IRS maintains an exclusive, rather than an inclusive, definition of taxable income. That is, all income is taxable income unless otherwise stated in the Internal Revenue Code. Some common examples of non-taxable income for individuals are:
The IRS cites the following as examples of taxable income for individuals and businesses:
The specific definition of taxable income changes from year to year as the Internal Revenue Code is updated through legislation or executive order.
In most industrialized countries, like the United States, in order for income to be recognized in the current year’s gross income and thus taxable, the income must be realized. The best example is the Supreme Court case of Eisner v. Macomber where the class of all common shareholders of a corporation who are all given proportionate stock dividends. In the form of a one for one stock dividend or stock split, none of the shareholders experience any change in their economic position, thus no realization. Another example is the unrealized capital gains that an asset owner has. Until the owner sells or otherwise obtains cash from the asset we have no realization. However, an owner need not sell an asset to experience the economic effect of realization. For instance, a shareholder with unrealized gains could buy a put on the same stock and then borrow cash equal to the put’s exercise price. This is the economic equivalent of realization and some tax systems recognize the use of derivatives to “cash in” on such gains.
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This glossary post was last updated: 25th April, 2020 | 0 Views.