Income taxes are a necessary, although unappealing, part of life. For both individual taxpayers and businesses, one key part of tax planning for lower rates is to understand what's taxable and what's not. Here's a short guide to help you make sense of it.
What Are Assets?
In general, an asset is anything you own which can bring greater financial benefit in the future.
The largest asset many individuals have is their primary home. The property is likely to appreciate (to grow) in value over time. This is an appreciating asset. However, it may also decline in value and create a loss in the future. However, while you own it, the asset doesn't necessarily bring in income right now.
What Is Income?
Income is simply money being received in the present. This most commonly comes as a trade-off for your investment of labor, for which you earn money from an employer. However, an asset, such as a stock, can also result in income in the forms of interest and dividends. Income taxes, as their name implies, focuses on income rather than assets.
When Is Income Taxable?
Many forms of income are taxable under federal and state tax rules. This includes various types of compensation from employers (including bonuses, vacation pay, and some benefits), income from the sale of stocks or bonds, income from a business activity, rental income, royalties, pensions, unemployment insurance, Social Security checks, and more.
Nontaxable income is much less common. It includes some Social Security, disability payments, some judgments, inheritances, and withdrawals from some retirement accounts. However, the more nontaxable income you have, the lower your tax bill.
When Is an Asset Taxable?
Owners of assets generally aren't taxed just for owning an asset, even if it rises in value. Your home appreciates, for example. However, that growth in value isn't taxed until it becomes income. When you sell the house, the proceeds of the asset become income to you. It is taxable in the year in which the sale occurs.
This is an important thing to remember. As long as you hold that asset, its value isn't taxed on you. Why? You likely paid taxes on the income earned to pay for that asset and that value isn't yet made tangible. However, if it generates income (like stock dividends), that portion is taxable.
Where Can You Learn More?
Do any of your assets provide income that could be taxable? Can you reduce your taxable income? Should you convert an asset into income through a sale? Get help answering these key questions by meeting with an accountant who specializes in tax planning in your state today.