Income is the base of your financial activities. Complex financial concepts like credit score, budgeting, acquisition etc. are directly related to your income. Remember, the concept of income can be highly delusive. By the end of this article you will learn about the basic concepts of income. Concepts like gross income, net income, adjusted gross income, annual income, passive income.
Basic Concept of Income
In earlier days of human civilization, the concept of income was very similar but not as précised as it is today. During the hunter-gatherer stage, there was no concept of currency. As the concept of currency evolved the income of a specific person could be defined. Let's assume, as a hunter-gatherer, you have gathered a handful of fruits to share with your family. Now if i ask you, what is the price of these gathered fruits, could you define it? I guess you couldn't. Actually none of us would be able to do so. Because there was no standard currency.
As the civilization walked forward to advanced & sophisticated financial systems currency was developed. In this stage anybody could define how much value is created through integrated efforts. Just like today we are doing businesses or working for other businesses or government organisations, there is a potential payback. After a certain period of time this amount will come to be as a reward of effort. Of course there are some metrics to measure. These metrics determines the value. The value is created through dedicated efforts.
What is Income?
The definition of income is very simple,
"Income is the amount of money you get from your recruiter or customer for the services you provide, product you make or sale. In a word for the value you have created under certain terms & Conditions."
Let's break it down. For example, Mr. Broad work for a software company as a senior developer. He has a fixed amount of wage, $6000 annually. So what is his monthly income? It is $500.
Now let's come to terms and conditions. If Mr. Broad is absent for 09 days will his income be the same as it is? If Mr. Broad takes bribes from other software companies to create malfunctions in the software he is working on, the bribe amount is increasing his income or not? To stay out of this complexities there are some general terms and conditions to define an amount as income of an individual,
- Certain amount of value should be created.
- There should be policies either written or oral.
- In a broader way agreements should be there that defines the product or service generating the value.
General Income Sources
In the earlier days when slavery was still legal, their was no such word as income for a section of people. Now in 2024, income is defined and anybody has equal right to another to work and earn. Throughout the evolution of the financial landscape types of income have increased. But the basic sources of income remained the same. Jobs and Businesses.
Job as a Income Source
In a business there are many operations and roles. Especially in bigger businesses. It is impossible for the owner to perform in every section equally as a human being. So businesses hire employees and assign them certain responsibilities. As a specific part of the entire operation is done by a specific employee after a certain period, the business rewards him with a prefixed amount. This amount is salary. And this transaction of labor and money is called a job. In 2024, approximately 3.5 billion people were employed worldwide. That is 50% of the world population. Job is the easiest income source for any individual. With skill it pays high, without skill it pays low. But it still pays. Job is the primary solution for income for even those who have a dream to own a business.
Businesses
Business is a very simple concept. I have something that creates lower value for me but higher for some others. I will provide this product or service to the individual looking for it. As it generates more value to that individual, I will be paid with a higher amount of money. The concept of business has roots back to the hunter gatherer stage of human civilization. More grains for a fish compared to its size or weight, more fish for a leather. These transactions were the earliest businesses. But as there was no concept of money (as we discussed earlier) these were not ideal examples of businesses. Remember as business can generate more value or can higher the value of a product or service business is the pillar of all kinds of financial activities in today's era.
Types of Income
As we have discussed some basic concepts of income, now we are ready to navigate the realm of different types of income. We talked about some terms and conditions of income. Based on these terms and conditions, types of income vary. Not only depending on those conditions even depending on the financial situation, types of incomes vary.
Gross Income
Gross income is the total amount of earnings. It may include salary, wages, tips, profit from investments. Any amount that is coming to an individual (we will discuss about financial ethics in our next blog) ethically for provided service or product is income and the sum of all these incomes is gross income.
Adjusted Gross Income
We could discuss net income, annual income, passive income prior to this but as taxation is a legal part and subject of penalty in case of violation we are discussing this section earlier than other sections. Adjusted gross income or AGI is a crucial concept in tax filing. It refers to your total income minus certain allowable deductions.
Gross income includes all the money you earn throughout the year, like wages, salaries, tips, interest earned on savings accounts, dividends from stock ownership, rental income from properties, and even capital gains from selling investments.
Adjustments to Income (Deductions) are specific deductions the government allows you to subtract from your total income before calculating your taxable income. Having a lower AGI can make you eligible for certain tax breaks. By understanding AGI clearly you can make informed financial decisions throughout the year and potentially reduce your tax burden come tax season.
Net Income
We have discussed the income sources. Jobs and businesses. Net income is more relatable to businesses. Any business has either a product or a service. There is an expense (the money is spent) to make this product or service usable, that is the cost of the product or service. After production the business will sell it. These sales will generate an amount. The difference between cost of the production and sales amount is net income.
Annual Income
Your annual income is your total earnings for a whole year. It includes everything you make, from your regular salary to any extra money you get like bonuses, commissions, or tips. People sometimes talk about it as your gross income or your net income for a fiscal year.
As a business your net income is the most important metrics to determine the success of your business. As an individual your income determines the ease of your life, the standard of your life-style. Socio-economic positions are determined by income. The more you make, the more you are safe financially. While the amount is important the ethical consideration is also important for sustainable income both for an individual and businesses.
Top 10 FAQs About Income
What's the difference between gross and net income?
Gross income is your total earnings before deductions or taxes. It includes wages, salaries, tips, and more. Net income is your take-home pay after deductions and taxes are withheld.
What are some common types of income?
- Wages and salaries
- Commissions
- Bonuses
- Tips
- Interest income
- Dividend income
- Rental income
- Capital gains (from selling investments)
- Royalties
How is my income taxed?
The tax system is progressive, meaning the more you earn, the higher percentage you pay. Your tax rate depends on your filing status and taxable income (gross income minus adjustments).
Employee Income:
What deductions come out of my paycheck?
Common deductions include federal income tax, Social Security and Medicare taxes, state and local taxes, and health insurance.
What are overtime wages?
Overtime pay is generally time-and-a-half your regular rate for any hours worked over 40 in a workweek.
What are minimum wage laws?
The federal minimum wage is the lowest hourly rate employers can legally pay most covered employees. Many states have their own higher minimum wages.
How do I report self-employment income on my taxes?
Self-employed individuals file a Schedule C form to report business income and expenses.
What deductions can I take as self-employed?
You can deduct many business expenses, like office supplies, travel costs, and health insurance premiums. You can also deduct half of your self-employment tax.
What are estimated taxes?
Self-employed individuals pay estimated taxes quarterly to avoid tax penalties.
What is dividend income?
Dividend income is a portion of a company's profits distributed to its shareholders.
What is capital gains tax?
Capital gains tax is the tax you pay on profits from selling investments like stocks, bonds, or real estate. The tax rate depends on how long you held the asset and your income tax bracket.
What is rental income?
Rental income is the income you earn from renting out a property.
What are royalties?
Royalties are ongoing payments made to the creator of intellectual property for each time their work is used.
