What

is Income?

Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings received... in a given period of time." For firms, income generally refers to net-profit: what remains of revenue after expenses have been subtracted. In the field of public economics, it may refer to the accumulation of both monetary and non-monetary consumption ability, the former being used as a proxy for total income.

Income

Concepts:

Accounting Concept of Income: Accounting income is defined as an estimate of performance in the operations of a company. It is influenced by financing and investing decisions. Accounting income or loss generally recognizes realized gains and losses, and does not recognize unrealized gains and losses. For income to be realized it must be related to actual business transactions; in effect, the cash you have must increase or decrease. A change in market value rather than cash received is not an accounting income; it is an economic income. Economic income or loss recognizes all gains and losses whether realized or unrealized. Central to the accounting profits definition is whether a gain or loss is realized or unrealized. When a gain or loss is realized it becomes an income suitable for accounting. The accounting value for this asset is generally listed at the historical

value of the transaction selling it. When a gain or loss is unrealized it may or may not be accounted for in general. This depends on the placement of the gaining or losing asset in the balance sheet. Despite that this gain or loss may be accounted for; the fact that it is unrealized makes it an economic income or loss. The accrual accounting income statement will look very different from the fair value accounting statement. Essentially, accounting income defined the ways companies evaluate their cash standing after the sale of an asset. This, once again, differs from economic income in that economic income is the way for companies to account for changes in the value of a given asset in the market. The deciding factor is whether or not a transaction takes place.

Accounting income defined by the following equation: Ia = R E Where, Ia = Accounting income R = Realized revenue of the period E = Expenses (corresponding history)

Accounting Conservatism Accounting income or loss does not incorporate unrealized gains and losses because of the convention of accounting conservatism. When accountants confront uncertainty in regard to method or procedure, they conventionally choose the option that is least likely to overstate income or asset value. In the case of realized versus unrealized gains and losses, it is more conservative from an accounting perspective to exclude increases or decreases in value that have not yet been actualized.

 Accounting Income Example A perfect example of accounting profit occurs every day in the stock market. Zata is a company which invests in market securities. Zata currently owns a share of AB stock worth $600. The following week Zata notices the share of AB stock has increased in value from $600 to $650. Zata sells this share of AB stock and receives $650 from the sale of one share of AB stock. Zata experienced an accounting income: their share of AB stock was sold for $50 more than it was initially worth. Thus, Zata has a realized accounting gain of $50. The accounting income calculation is $650 - $600 = $50. If Zata never sold the share of AB stock it would have experienced an economic gain of $50. This is shown by the fact that Zata did not have a transaction in which cash increased by $50.

Accounting Income vs. Taxable Income The treatment of accounting income and taxable income is different. The inclusion of tax accounting confuses the matter. Under GAAP, income and expenses are matched to the period in which they are incurred. This means that the accounting income Investors received was incurred on the specific day that it sold the share of Google stock. With tax accounting, however, taxable income and expenses are matched to the period upon which the I.R.S. decides. Investor may or may not incur an increase in taxable income based on I.R.S. regulations. It has incurred this potential increase in the accounting period the I.R.S. chooses. This means that an accounting income under GAAP may not be considered an accounting profit under I.R.S. tax rules.

 Economic Concept of Income

Economic income is the amount a person or firm can afford to spend during a given period, and be as well-off at the end of it as at its beginning. Economic income is a term that is used to describe the amount of income that an entity can comfortably spend during a specified period of time and be in essentially the same financial position at the end of the period as at the beginning. Sometimes referred to as surplus, this type of income is what is left over after all basic financial commitments are fulfilled, and can be spent freely without endangering the entitys financial standing in any way. Both households and businesses generate economic income, and can choose to use this income in several different ways. When the concept of economic income is applied to the household budget, the term usually refers to the amount of income that remains after all essentials have been purchased for the period. Essentials include such items as food, clothing, and shelter, making the minimum payments on outstanding loans and credit card bills, or handling any other standing obligation that comes due during the period. Once these basic living needs are settled for the period, the household is free to make use of the any remaining income as it sees fit. A household can choose to do any number of things with economic income. Some may choose to take a portion of this income and place it into an interest bearing account, such as a savings account or a certificate of deposit. Others may choose to use the surplus as a way of purchasing items that are wanted but not necessarily needed for the operation of the household. With either scenario, spending this extra income does not pose a threat to the stability of the household. Businesses use the same basic model when determining what is and is not economic income. Any profits that remain after paying taxes, all expenses associated with the operation of the company, and other standing obligations would be considered economic income. These funds could be used for anything from throwing a party for the employees to providing charitable donations to the community.

 Accounting Income vs. Economic Income

Accounting income or loss recognizes realized gains and losses, and does not recognized unrealized gains and losses. Economic income or loss recognizes all gains and losses, whether realized or unrealized. Gains and losses are realized only when the related transaction is settled or completed. Until a transaction is completed, any gains or losses related to that transaction are considered unrealized. Unrealized gains and losses are also called paper gains or paper losses, because the nominal value of the asset or liability has changed, but the cash has not actually changed hands.

Accounting Conservatism Accounting income or loss does not incorporate unrealized gains and losses because of the convention of conservatism. When accountants confront uncertainty in regard to method or procedure, they conventionally choose the option that is least likely to overstate income or asset value. In the case of realized versus unrealized gains and losses, it is more conservative to exclude increases or decreases in value that have not yet been actualized.

Accounting Income vs. Economic Income Example: Here is a simple example dealing with an individual. Karim earns $50,000 dollars per year salary, after tax, and has $10,000 dollars invested in the stock market. At the end of the year, his stock market investment is worth $15,000. Because Karim has not yet sold his stock and collected the profits, the increase in value of the investment is considered unrealized. It is a paper profit. At the end of the year Karim has a realized income of $50,000 from his salary. His total realized income is $50,000. He has unrealized profits of $5,000 dollars. His combined realized and unrealized incomes equal $55,000. In this example, Karims accounting income would be $50,000 and his economic income would be $55,000. According to accounting income, the increased value of

the stock investments do not count as actual income because the investor has not actually sold the stock, completed the transaction, and collected the profits. According to economic income, the increased value of the stock investments to count as actual income because the real value of the assets has gone up. The assets are worth more now than they were at the beginning of the year. In this sense, Karim has earned the full $55,000 income.

Business income:
The basics of the business income versus non-business income distinction are familiar to most state tax practitioners. A multi-state taxpayer's "business income" is income from transactions and activities in the regular course of its trade or business, and includes income from tangible and intangible property when the acquisition, management, and disposition of the property are integral parts of the taxpayer's regular trade or business. A multi-state taxpayer's "non-business income" includes everything else. The significance of this distinction should also be familiar to tax professionals. In determining how much of a multi-state taxpayer's income is taxable in any given jurisdiction, the business income of the enterprise is apportioned among the states where the taxpayer does business using an apportionment formula. The nonbusiness income is allocated in its entirety to a single state based on either the geographic source of the income or, in the case of income from interest, dividends, and capital gains, on the commercial domicile of the taxpayer. The tax practitioner will find at least some formulation of these rules in the statutes and regulations of almost every state imposing a corporate income tax. But the business income versus non-business income classification turns on more than a formalistic set of rules. According to some, relevant issues include how many like assets the taxpayer has bought or sold since its corporate inception, the "conditions of ownership" of an income-producing asset, and if the uniform "business income" definition contains a misplaced modifier or a compound predicate. Deciding whether a state may require a taxpayer to include an item of income in the apportion able tax base is an exercise compelled by the United States Supreme Court's Commerce Clause and Due Process Clause jurisprudence. This article

seeks to unite, or as some might say, reunite, the state law business income/nonbusiness income provisions with their origins in the Supreme Court cases. This article begins by discussing the decision in Mobil Oil Corp. v. Commissioner of Taxes ("Mobil Oil"), where the Court proclaimed that "the linchpin of apportion ability" is the unitary business concept, then follows the constitutional trail to the Court's most recent pronouncement on the issue in Allied-Signal, Inc. v. Director, Division of Taxation ("Allied-Signal"), where the Court announced that there is another "linchpin" to consider. Next, this article presents a case study in how courts and state tax authorities have applied the analytical framework established by the Court's apportionment cases. Finally, the article discusses the business income/non-business income classification in the context of state law, and examines state court rulings spotlighting the analytical intersection between the income classification systems found in state statutes and regulations and its origins in the Supreme Court's Commerce Clause and Due Process Clause cases.