Last week we started a four-part series covering the basics of the standard personal income tax return by taking a look at how to choose the right filing status. This time we’ll take a look at the question of what is income. While this might seem like an obvious question, it doesn’t take much digging to find out the answers aren’t always so clear cut.
Congress takes a pretty broad view of what is considered taxable income. Generally, any money, property, or services you receive is considered income, unless the law specifically excludes an item. Obviously this includes the paycheck you receive for working or interest earned on a savings account. It also includes wages paid in cash (aka “under the table”), income received through bartering (minus your basis in any property you gave up), and tips received while working. (Though see this article explaining why reporting tips might make you better off, aside from the simple legal angle.) Even money or property that you simply find is considered income–yet another reason not to bother bending over to pick up that penny on the ground.
However, Congress has carved out several exceptions. For instance, gifts and inheritances are not considered income, so don’t worry about adding your Christmas gifts to your tax return. However, a gift is only a gift if it’s given with the expectation of nothing in return. For this reason, employer “gifts” to employees are basically always considered taxable income because there’s an implicit expectation that the reason an employer gives gifts to employees is as compensation for the services the employee provides.
Also, there are special rules allowing certain types of income to be excluded. Certain fringe benefits an employer provides don’t have to be counted as income. By far the biggest item in this category is employer-provided health insurance. But this can also include foreign income if certain conditions are met, most government assistance payments (e.g. food stamps, welfare, etc.), many Social Security payments, scholarships that are used for qualified education expenses, and so forth. One of the best clues as to whether a payment is taxable is whether or not it’s reported on a Form 1099. There are various “flavors” of 1099’s, but if you receive a large payment during the year, and you don’t receive a 1099 (or W2) reporting the payment, that’s a good indicator the payment is not taxable. You should still do your homework if you’re not sure though!
Also, there are situations where taxpayers have income that doesn’t immediately seem like it should be income. The most common example of this, particularly in recent years, is cancellation of debt income.
If you had a home foreclosed on, a car repossessed, or a credit card debt cancelled, you probably received a 1099-C or a 1099-A. You have “cancellation of debt” income. This occurs because when you took out the original loan, you received money that was not considered income. It wasn’t considered income because you had an obligation to pay the money back…so the money you received was exactly offset by the obligation to repay that money. However, once the debt was cancelled, the situation is different. Now that you’re no longer obligated to repay the debt, the money you received earlier but are no longer required to repay is considered income. This can seem harsh to people who’ve had a home foreclosed or lost a vehicle. However, if there weren’t laws like this, people could receive tax-free income by taking out loans and defaulting on them. And fortunately, there are multiple circumstances that allow people who’ve had debts cancelled to avoid having to treat the cancelled debt as income. (The debt cancellation possibilities require a very lengthy article of their own.)
So when it comes to reporting your income, unfortunately nearly everything you would possibly think to include (and even some things you wouldn’t), has to be included in your gross income. Be aware of the exceptions though, so you don’t report more income than you have to. And in the next article we’ll look at ways to deduct items from your gross income to arrive at your (hopefully much lower) taxable income.