What does the tax code mean by the term “income”? The tax law doesn’t care whether you receive income from your business, W2 wages paid by your employer or from an investment you made 3 years ago. It is taxable to you as an individual.
Definition of Business Income
Besides the obvious, receipt of cash, stocks and bonds, income for tax purposes can take many forms.
Goods and services. Goods, property or services received are within the definition of income.
Constructive income. As soon as money or property is available to you (constructive receipt), or is credited to your account, it becomes income-whether you take it or not. For instance, if you provided services in November 2015, received the check and wait until January 2016 to deposit it, it’s still considered income for 2015.
Illegal income. The tax code is neutral and doesn’t distinguish between illegal and legal income. Al Capone wasn’t sent to prison for murder, bootlegging or racketeering; he was convicted of tax evasion for not reporting the fruits of his labors to the IRS.
Worldwide income. Americans are taxed on their worldwide income, no matter where earned it is still taxable in the United States. There are some exceptions (and tax credits available) to those that actually live outside the United States and are paying foreign taxes as well.
What Isn’t Income: Exclusions
Gifts and inheritance. The tax code specifically excludes gifts and inheritances from taxable income, no matter how much you receive. (Lottery winnings and Publishers Clearinghouse checks are not legally a gift and are taxable!)
Fringe Benefits. Thankfully, many so-called fringe benefits provided by businesses to owners and employees are specifically excluded from income (see below!)
Return of capital. For the business owner or investor, the return of a capital investment is not taxable income. For example, to the extent that you sell a business or any asset and get back your investment, you haven’t earned any taxable income. Only the gain, if any, is taxed. Example: Fred invests $1,000 in the stock of Inspired Living, Inc., and later sells his stock for $1,500. Only $500 is taxable income, the other $1,000 is a return of Fred’s capital.
Tax-free withdrawals. If you borrow against an asset, whether it belongs to you personally or the business, the loan proceeds are not income.
Destroyed or Stolen Assets. If a business asset becomes damaged, destroyed or stolen, the tax code considers this an “involuntary conversion.” If the loss was covered by insurance, there’s no tax consequence or depreciation recapture, as long as all the insurance proceeds are used to replace the asset.