Friday Flashcards
What is income
Income is defined as a gain or recurrent benefit, usually measured in money, that derives from capital or labour.
It represents the amount of money or value received over a period of time in exchange for services or products, and can also include earnings from investments, property, and other sources.
In the context of taxation, in income is the gross amount earned minus any exclusions, exemptions, and deductions allowed under tax law.
How do most people earn their income? What other sources of income exist?
Most people earn their income through employment, which includes salaries and wages for work performed as a employee.
This can also encompass overtime pay, bonuses, commissions, tips, and gratuities for those in the service industry.
Self-Employment Income: Earnings from running a business or working independently, including freelancers, consultants, and small business owners.
Interest Income: Payments received from owning shares in a company.
Dividend Income: Payments received from owning shares in a company.
Rental Income: Earnings from renting out property or real estate.
Capital Gains: Profits from the sale of assets like stocks, bonds, or real estate.
Royalties or Licensing Income: Payments for the use of intellectual property, such as patents, copyrighted works, or trademarks.
Passive Income: Earnings from ventures in which a person is not actively involved, such as earnings from a business partnership.
These diverse income streams can be part of a strategy to build financial stability and wealth over time. It’s common for individuals to have multiple income streams to diversify their earnings and reduce financial risk.
Gross Income, Disposable Income. and discretionary Income
Gross Income: This is the total earnings received by an individual or business before any deductions or taxes are deductions or taxes are taken out. it includes wages, salaries, bonuses, rents, interest, and dividends.
Disposable Income: This is the amount of money that individuals or households have available for spending and saving after income taxes have been accounted for. It’s essentially the net income after tax.
Discretionary Income: This is the income that remains after subtracting taxes and all necessary living expenses, like rent, utilities, food, and transportation. It’s the money available for non-essential purchases and savings.
What factors decrease how much income tax you will need to pay?
Taxable Income: The amount of taxable income you have determines your tax bill. The federal tax system is progressive, meaning that generally, your tax rate increases as your income increases.
Filing Status: Your taxes also depend on your filing status. For example, married persons who file jointly typically have a higher income threshold for each tax bracket compared to single filers.
Retirement Contributors: Maximizing contributions to retirement plans like a 401(k) or traditional IRA can reduce your taxable income.
Health Saving Accounts (HSA) Contributions to HSAs are tax-deductible and can lower your taxable income.
Tax Credits and Deductions: Various tax credits and deductions, such as those for education expenses, charitable donations, and mortgage interest, can reduce your tax liability.
Tax-Loss Harvesting: Selling investments at a loss to offset capital gains can reduce taxable income.
Flexible Spending Plans: Some employers offer flexible spending plans that allow money to be set aside pre-tax for expenses like medical expenses.
These strategies can be used to legally minimize the amount of income tax owed. It’s always a good idea to consult with a tax professional to understand how these factors apply to your specific situation.
How to calculate income. with gross income (monthly), deductions, disposable income, cost of necessities. and discretionary income.
Calculating income involves several steps, each relating to different aspects of your financial situation. Here’s a breakdown of how to calculate each factor:
- Gross Income: This is your total earnings before any deductions. For individuals, it includes wages, salaries, bonuses, and any other income. To calculate monthly gross income, you would sum up all these earnings within a month.
- Deductions: These are amounts subtracted from your gross income, primarily for taxes, and may include other items like retirement contributions. The total amount of deductions depends on tax rates and any additional contributions you make.
- Disposable Income: This is the money you have left after taxes and mandatory deductions. To calculate it, subtract the total deductions from your gross income. Disposable income is what you use for your regular expenses.
- Cost of Necessities: This refers to the essential expenses such as housing, food, utilities, and transportation. You can calculate this by adding up all your monthly bills and essential spending.
- Discretionary Income: This is the income left over after paying for the necessities. It’s what you can use for savings, investments, and non-essential purchases. To find your discretionary income, subtract the cost of necessities from your disposable income.
Here’s a simple formula to illustrate the process:
Discretionary Income = Gross Income - Deductions - Cost of Necessities
Terms Explained:
- Gross Income: The total income earned before any deductions.
- Deductions: Amounts subtracted from gross income, mainly for taxes.
- Disposable Income: Income remaining after taxes and mandatory deductions.
- Cost of Necessities: Expenses for essential needs like housing and food.
- Discretionary Income: Income available after covering all necessary expenses.
