Understanding the basics of income is fundamental for financial literacy. Income includes various financial streams, and distinguishing between terms like revenue and income is key. This guide will explore all about income, its types, taxation on earned income, business income, and the concept of taxable income.
What is income?
Income refers to the money earned by an individual or a business, representing the inflow of financial resources. It includes various sources like salary, interest, and profits, shaping the overall financial health.
Types of income
Understanding different types of income helps in better financial planning as every source contributes differently to an individual's or business's financial health.
- Earned income: This is money made through personal efforts like a job or freelancing, which is a major source of income for many individuals.
- Passive income: This involves generating money with little active involvement, often from investments or assets such as rental properties.
- Portfolio income: This type of income is realised when financial assets like stocks or bonds are sold at a profit.
- Business income: It represents the total money a business makes from its operations before the deduction of expenses. This includes revenue from product sales or services.
- Interest income: You earn interest income when you lend money, typically through savings accounts, bonds, or loans.
- Rental income: It's the income derived from renting out property, and it contributes to financial inflows.
- Dividend income: Such income is earned when you own shares in a company.
- Royalty income: This type of earnings come from granting permission for others to use intellectual property - be it patents, copyrights, or trademarks.
How is earned income taxed?
Understanding how earned income is taxed is crucial for managing personal finances. Earned income includes wages, salaries, bonuses, and other compensation earned through active personal efforts.
Firstly, tax brackets play a significant role. Tax brackets categorize income levels, with each bracket assigned a corresponding tax rate. This means that the more you earn, the higher the tax rate applied to that portion of your income. For example, in a progressive tax system, lower-income earners may face a lower tax rate, while higher-income earners may experience higher rates. In India, income tax slabs determine the applicable tax rates based on annual income. For individuals below 60 years, the slabs include 5%, 10%, 15%, 20%, and 30%, depending on income levels.
Secondly, standard deductions and exemptions are essential in reducing taxable income. These are predetermined amounts subtracted from your total income before calculating taxes.
Furthermore, tax credits and deductions can further ease the tax burden on earned income. Tax credits directly reduce the amount of taxes owed, while deductions reduce taxable income. For instance, claiming deductions for expenses like mortgage interest, student loan interest, or contributions to retirement accounts can lower your taxable income.
The taxation of earned income involves several components like, tax brackets, standard deductions, exemptions, and credits. Familiarizing oneself with these elements is essential for effective financial planning, helping individuals improve their tax situation and preserve more of their hard-earned money.
Business income
Business income, often referred to as gross income, includes the total earnings before deducting expenses. It reflects the effectiveness of a business in generating profits from its core operations, such as selling goods or services.
For businesses, understanding and effectively managing this income are critical for sustainability and growth. Monitoring business revenue involves tracking sales, services rendered, and other income streams. Once the gross income is determined, businesses subtract various operating expenses like rent, utilities, and employee salaries to arrive at the operating income.
The ability to generate a positive and sustainable business income is indicative of operational efficiency and profitability. For entrepreneurs and business owners, optimizing this income involves strategic decision-making, pricing strategies, and identifying opportunities for revenue growth. It also forms the basis for financial planning, investment decisions, and assessing overall business performance.
To support your financial needs, consider exploring a business loan for tailored financial solutions.
What is taxable income?
Taxable income is the portion of one's income subject to taxation after accounting for deductions and credits. It serves as the basis for calculating income tax liabilities, providing a clear understanding of the financial responsibilities individuals and businesses bear.
Which categories of income are tax-exempt?
In India, certain categories of income are tax-exempt, including agricultural income, income from interest on certain savings schemes like PPF and EPF, income from investments in tax-free bonds, and income from certain allowances like HRA and LTA. Additionally, gifts received on specified occasions, such as weddings, are also tax-exempt up to a certain limit.
What is not considered as income?
Not considered as income are gifts received from relatives, scholarships for education, and proceeds from life insurance policies. Additionally, gratuity, pension, leave salary, awards, and certain allowances are not considered as taxable income.
Similarly, if a family has what's known as a Hindu Undivided Family (HUF), the income generated from the property owned by this family isn't taxed up to a specific limit. The HUF is a unique concept in Indian taxation, where the family, rather than individuals, is considered as the taxpayer. Income from the family's property, whether it's from investments, rental income, or any other source, is pooled together and taxed as a unit.
