What is income? This is one of the best places to begin if you are trying to cultivate an understanding of your tax obligations, and it is also where law school classes on the federal income tax often begin.
The terminology used by tax lawyers regarding what is income, is: accessions to wealth. This phrase comes from a 1955 Supreme Court case, Glenshaw Glass v. Commissioner, excerpted here: “Here we have instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”
Accession to wealth is a fancy way to say - anything that makes you financially better off than you were before the event. This language is deliberately broad because there are quite a few examples of non-cash income. You can have an ‘accession to wealth’ without the value of your bank account changing and without having the pile of cash under your bed grow.
If someone pays you to do (or even to not do) something, that is income. This includes services that you perform for your employer but also one-off services that you provide. Remember when you were a kid and you mowed your neighbors lawn a few times or babysat your neighbors kids? Yeah, that’s income.
The normal range of investments also generate income. Renting something to someone, holding your money in an interest bearing account, holding on to shares of stock in a company that pays dividends, selling something for more than you paid for it, essentially any investment that generates value for you.
Some people may be surprised to learn that gambling winnings are also considered taxable income, and no I’m not just talking about hitting the lottery, but also about those slot machine winnings and even that $20 you may or may not have won betting on the superbowl.
Even more surprising, found money is also income. If your dog digs up a bag of money in your backyard… you have income.
There are also quite a few examples of noncash income. For example, if you are a plumber and your friend is a hairdresser and you agree to install a new toilet for him if he cuts your hair, you both have income. In this example the amount of the income will be the fair market value of the services provided to you, as you received these services as payment for the services that you provided to your friend.
A second example of noncash income is, if you bought a rare coin twenty years ago for $10 and you trade it for a new $600 Iphone, you will have $590 of income.
Basically, if you acquire anything of value, cash or otherwise, you probably have income. It’s a bit easier to highlight the select few things that aren’t considered income than it is to go over the nearly unlimited number of things that are income.
Items That Are Not Income
The most prominent item on this list is gifts. Under the U.S. tax system, gifts are taxable to the gift giver (with a sizable annual exclusion of $15,000 per gift recipient). There are very very few circumstances in which an individual will be taxed for a gift that he received.
Another ‘accession to wealth’ that isn’t taxable to the recipient is alimony. Prior to the tax reform of 2017, alimony was taxable income for the recipient and was deductible to the payor. This changed with tax reform, and now the receipt of alimony isn’t taxable at all (for divorce decrees finalized after 12/31/2018). Additionally, child support is also not considered income to the recipient.
Excluding these few items (and a few other less common examples), the question you need to ask about anything you think may be income is - is everything I have worth more on account of this transaction/exchange/receipt? A good transaction to review to emphasize this point is a loan that you take from your bank to purchase a home. In the case of a loan, while you have acquired cash, you have also acquired an obligation to repay that cash. This is why it isn’t income every time you use your credit card, because each swipe of the card comes with a promise to repay the amount used. Take a step back and consider a situation wherein the credit card company, usually because they have concluded that they will never be able to collect the balance, opts to forgive your credit card debt. When that obligation to repay the debt is cancelled, you have income. Cancellation of debt is a particularly awful type of income that can really surprise people come tax time.
Following this same line of reasoning you can see why it can be a bit complicated to determine when amounts you receive from a lawsuit will and won’t be income. If someone is caught damaging your property and you bring them to court and win, the amount awarded to you as compensatory damages (which means the amount awarded to you to offset the value of the damage) is not considered income, because these funds are bringing you back to the same financial situation that you would have been in if the the damage hadn’t occurred. If, in addition to the compensatory damages, the judge awards ‘punitive damages’ (amounts required to be paid to punish the individual), these amounts will be considered income to you because they are providing you with more value than you would have had based on the value of the item that was stolen.
Exceptions, Exclusions, Credits, Deductions, etc
In this article we are discussing what is and what is not considered income, but it is also important to note that there are a very large number of exceptions, exclusions, credits, and deductions that can cause an item of income to avoid becoming taxable income. Some of these deductions will apply to reduce all of your income (like the standard or itemized deductions) and some will only impact the specific items of income (like the closing costs of a house sale). We’ll dig more into these exceptions, exclusions, and credits in a later article, but do note that just because an item is ultimately untaxed, does not mean that it wasn’t still income.
There are also quite a few examples of noncash income, like, if you are a plumber and your friend is an electrician and you agree to install a new toilet for him if he installs a new light fixture for you, you both have income. In this example the amount of the income will be the fair market value of the services provided to you, as you received these services as payment for the services that you provided for your friend.
Additionally, if you bought a rare coin twenty years ago for $10 and you trade it for a new $600 iPhone, you will have $590 of income.
Basically, if you acquire anything of value, cash or otherwise, you probably have income. It’s a bit easier to highlight the select few things that aren’t considered income than it is to go over the nearly unlimited number of things that are income.
Items That Are Not Income
The most prominent item on this list is gifts. Under the U.S. tax system, gifts are taxable to the gift giver (with a sizable annual exclusion of $15,000 per gift recipient). There are very very few circumstances in which an individual will be taxed for a gift that he received.
Another ‘accession to wealth’ that isn’t taxable to the recipient is alimony. Prior to the tax reform of 2017, alimony was taxable income for the recipient and was deductible to the payor. This changed with tax reform, and now the receipt of alimony isn’t taxable at all (for divorce decrees finalized after 12/31/2018). Additionally, child support is also not considered income to the recipient.
Excluding these few items (and a few other less common examples), the question you need to ask about anything you think may be income is - is everything I have worth more on account of this transaction/exchange/receipt? A good transaction to review to emphasize this point is a loan that you take from your bank to purchase a home. In the case of a loan, while you have acquired cash, you have also acquired an obligation to repay that cash. This is why it isn’t income every time you use your credit card, because each swipe of the card comes with a promise to repay the amount used. Take a step back and consider a situation wherein the credit card company, usually because they have concluded that they will never be able to collect the balance, opts to forgive your credit card debt. When that obligation to repay the debt is cancelled, you have income. Cancellation of debt is a particularly awful type of income that can really surprise people come tax time.
Following this same line of reasoning you can see why it can be a bit complicated to determine when amounts you receive from a lawsuit will and won’t be income. If someone is caught damaging your property and you bring them to court and win, the amount awarded to you as compensatory damages (which means the amount awarded to you to offset the value of the damage) is not considered income, because these funds are bringing you back to the same financial situation that you would have been in if the the damage hadn’t occurred. If, in addition to the compensatory damages, the judge awards ‘punitive damages’ (amounts required to be paid to punish the individual), these amounts will be considered income to you because they are providing you with more value than you would have had based on the value of the item that was stolen.
Exceptions, Exclusions, Credits, Deductions, etc
In this article we are discussing what is and what is not considered income, but it is also important to note that there are a very large number of exceptions, exclusions, credits, and deductions that can cause an item of income to avoid becoming taxable income. Some of these deductions will apply to reduce all of your income (like the standard or itemized deductions) and some will only impact the specific items of income (like the closing costs of a house sale). We’ll dig more into these exceptions, exclusions, and credits in a later article, but do note that just because an item is ultimately untaxed, does not mean that it wasn’t still income.