In general, income is taxable unless it is specifically exempted by law. Thus, it must be reported and subject to taxation. On the other hand, nontaxable income may still need to be reported on your tax return.
Constructively received income:
Even if you haven’t cashed a valid check received before the end of a certain tax year, it is still considered income constructively received in that year, thus making it taxable. For example, if the check was mailed to you but you weren’t available to receive it, you must still include it in your income for the year it arrived, even if it was the last day of the tax year.
However, if the check was mailed in a way that restricted access to the funds before the end of the tax year, it would be counted as income for the following year. Similarly, income received by your agent is also considered income constructively received in the year of its receipt. If a third party receives income on your behalf, it must be included in your income for the year the third party receives it.
Compensation for future services:
In most cases, compensation for future services is counted as income in the year it is received. However, if you use an accrual method of accounting, taxation of prepaid income received for the next tax year is deferred, and the payments are included as income earned when you perform the services.
Now, let’s delve into other forms of income and their tax implications as outlined by the IRS.
Employee compensation:
All compensation received for personal services, including fringe benefits and stock options, must be included in your gross income. The payment amount can be found on your W-2 form. If you provide childcare services in any location (child’s home, your own home, or elsewhere), you must include the payment as income. If you’re not an employee, report the payments on Schedule C, Profit or Loss from Business. Childcare regulations apply when babysitting for relatives or neighborhood children on a regular or occasional basis.
Fringe benefits:
Fringe benefits are generally treated as compensation unless you pay fair market value or they are excluded by law. If you have a noncompete agreement and haven’t yet provided services, treat them as if they have been performed. Even if you give the benefit to someone else, you are still considered to have received it. Fringe benefits can be received by a partner, director, or independent contractor.
Partnership Income:
Partnership income is not subject to taxation. However, partners receive their respective shares of income, gains, losses, deductions, and credits. Even if the income is not distributed, partners must report their share on their tax returns. Losses are limited to the adjusted basis of the partnership interest at the end of the year in which the losses occurred.
S Corporations:
S corporations do not pay taxes on income as it is passed through to shareholders. Income, losses, deductions, and credits are passed through based on the shareholders’ stock ownership. Nevertheless, shareholders are still required to report these items on their tax returns. Form 1120-S should be used to present the corporation’s results and items affecting shareholders’ tax returns.
PTET Changes the Rules:
Additionally, it is important to note that some states have a pass-through entity tax (PTET) which can impact the situation. PTET is a state or local tax on entities classified as pass-through entities for federal purposes. The IRS has clarified that the payment of PTET to domestic jurisdictions is deductible when computing the entity’s nonseparately stated income or loss. It is not considered in applying the cap to individual partners or shareholders. The rules regarding PTET are complex, so it is advisable to consult a tax advisor to determine if PTET can be beneficial for your circumstances.
Royalties:
Income from royalties obtained from copyrights, patents, and oil, gas, and mineral properties is taxable. Royalties should be reported in Part 1 of Schedule E, Supplemental Income and Loss. If you are self-employed, report income and expenses on Schedule C. Further details can be found in Publication 525, Taxable and Nontaxable Income.
Virtual Currencies:
Tax liability can arise from dealing with virtual currencies, whether through sales, exchanges, purchases of goods or services, or investments. These transactions should be included in your income at their fair market value at the time of receipt. For more information, refer to Tax Topic 420.
