Article Highlights:

• A Simple Example, Finding Money On The Street
• What Section 61 Is Designed To Do
• The Basic Idea: Accession To Wealth
• What Is Usually Taxable?
• What Is Usually Not Taxable?
• The General Welfare Exclusion
• State Tax Refunds Are Not Always Taxable
• What About Prizes, Awards, and Gambling Winnings?
• Examples of Expressly Excluded Income
• Final Thoughts

Most people think “income” means a paycheck. But for tax purposes, income is much broader than that. Under the Internal Revenue Code Section 61, gross income generally means all income from whatever source derived, unless a specific rule says it is excluded. In simple terms: if you got something of value and the tax law does not carve it out, the IRS probably sees it as taxable.

A helpful way to think about it is this: If your wealth goes up, and the tax law does not give you an exception, it may be income. That sounds broad because it is broad.

A Simple Example, Finding Money On The Street

Suppose you are walking down the sidewalk and find a $100 bill on the ground. You pick it up. It is yours. You can spend it. That is generally taxable income.

Why? Because you received something valuable that increased your wealth, and you had control over it. It was not a gift from a family member or a friend, and it was not a refund of money you previously paid. It was new money you found and kept.

Now suppose instead you find a gold ring in a river or even a small nugget of gold. That is also generally taxable when you take control of it, and it becomes yours. The tax law does not care that you found it instead of earning it at work. What matters is that you received something of value.

This is one of the easiest ways to understand this section of the tax code: if you gain something valuable, and no exception applies, it may be taxable.

What Section 61 Is Designed To Do

Section 61 is the starting point for federal income tax. It is designed to catch all kinds of income. That means income can include:

• wages and salaries,
  
  
• bonuses,
  
  
• freelance and side hustle income,
  
  
• business income,
  
  
• rent,
  
  
• interest,
  
  
• dividends,
  
  
• prizes and awards,
  
  
• gambling winnings,
  
  
• debt forgiveness in some cases, and
  
  
• many other forms of gain.

Many taxpayers are surprised by this. They may think, “I didn’t get a W-2 or a 1099, so maybe it’s not taxable.” But the IRS does not limit income to W-2 wages and 1099 reported income. If something increased your wealth, the tax rules may treat it as income even if no employer paid it.

The Basic Idea: Accession To Wealth

Tax law often uses a phrase that sounds fancy but is actually simple: accession to wealth.

That just means your finances got better. For example:

• If your employer pays you $1,000, your wealth increased (even if only for the limited time before you spend that paycheck).
  
  
• If a customer pays your side business $500, your wealth increased.
  
  
• If you win a $2,000 prize, your wealth increased.
  
  
• If you find $100 cash, your wealth increased.
  
  
• If a debt is forgiven, your wealth increased.

The key question is whether the taxpayer had control over the money or property and whether there is a rule that makes it non-taxable. So, if you receive a payment and can keep it, use it, or spend it, that is usually a sign that it may be taxable unless an exclusion applies.

What Is Usually Taxable?

Here are some common examples that taxpayers often forget about:

• Side Hustle Income: If you drive for a rideshare company, sell items online, do graphic design, house cleaning, tutoring, or any other paid work, that is generally reportable income. Expenses related to this income may reduce the amount that is taxable.
  
  
• Cash App or Venmo Payments: If someone pays you for services through an app, it is still income. The method of payment does not change the tax result.
  
  
• Prizes and Awards: If you win a car, trip, gift card, or cash prize, it is often taxable. Even if you never asked for the prize, if it has value, it may be included in income. This may give you a whole new perspective when watching those game shows on TV and realize taxes are due on the winnings.
  
  
• Gambling Winnings: Lottery winnings, casino winnings, and similar gambling winnings are taxable.
  
  
• Found Property: Money found on the street, abandoned property, or treasure found is generally taxable when it becomes yours.
  
  
• Cancellation of Debt: If a creditor forgives a debt, that can create taxable income unless an exception applies, such as bankruptcy or insolvency.
  
  
• Gain When Property is Sold: Generally, just the difference between the sales price and cost of the property is taxable. Whether the gain is considered a capital gain (and eligible to be taxed at a lower tax rate) or ordinary gain depends on how long you owned the property and what it was used for.
  
  
• Illegal Activities Income: Even money made from illegal activities is taxable. That is what brought down the notorious Chicago mob boss Al Capone.

What Is Usually Not Taxable?

Now for the part taxpayers really want to know, what doesn’t count as income? There are many exclusions, but here are some of the most common ones.

• Gifts: If your parent gives you $1,000 for your birthday, that is generally not taxable to you. Why? Because the money was given out of generosity, not as payment for work or services. But be careful: if someone calls a payment a “gift” when it is really pay for something you did, it may still be taxable.
  
  Example: Your friend gives you $200 for helping move furniture all day. That is probably not a gift. It may be taxable compensation.
  
  
• Inheritances: Money or property you inherit is generally not taxable when you receive it.
  
  Example: If you inherit a bank account from an aunt, the inheritance itself is usually not taxed to you. However, if that account earns interest after you inherit it, the interest is taxable.
  
  
• Certain Life Insurance Proceeds: In most cases, life insurance paid because someone died is not taxable to the beneficiary.
  
  
• Some Scholarships: Qualified scholarship amounts used for tuition and required school expenses may be excluded.
  
  
• Some Personal Injury Recoveries: Certain damages from personal physical injuries or physical sickness may be excluded, though there are many details and exceptions.
  
  
• Some Government Assistance: Certain government payments may be excluded, especially if they are part of a welfare or disaster relief program.

The General Welfare Exclusion

One of the most important ideas for everyday taxpayers is the general welfare exclusion. This rule can apply when a government program gives money to people who need help with basic living expenses or disaster recovery. The idea is that if the payment is meant to help people meet their needs, and not to compensate them for services, it may not be taxable.

• Examples:
  
  o   disaster relief payments
  
  o   housing assistance
  
  o   food assistance
  
  o   utility assistance
  
  o   emergency aid after a fire, flood, or other disaster

Example: If your city gives you emergency assistance after your home floods, that payment may not be taxable if it fits the rules for disaster relief. But if the government pays you because you worked for them, that is usually taxable wages, not welfare assistance.

 Another Example: If a state program gives a low-income family money to help pay rent, that may be excluded if it is a qualifying general welfare payment.

The idea is that the program usually has to be:

• From a government source,
  
  
• Based on need, and
  
  
• Not payment for services.

State Tax Refunds Are Not Always Taxable

Taxpayers often ask about the taxability of state tax refunds. The answer is: sometimes yes, sometimes no.

If you took the standard deduction and did not benefit from deducting the state income taxes you paid on your federal return, then a state refund is usually not taxable.

But if you itemized deductions in a prior year and deducted state taxes, part or all of the refund may be taxable in the later year under the tax benefit rule.

Example: You itemized deductions last year and deducted $5,000 of state income tax. This year, you receive a $1,000 state tax refund. That refund may be taxable because you already got a tax break from deducting the taxes last year.

If you took the standard deduction and got no tax benefit from deducting state taxes, the refund is usually not taxable.

What About Prizes, Awards, and Gambling Winnings?

These are common surprises for taxpayers.

• Prize Example: You win a new television on a TV game show or in a lottery sponsored by a charitable organization. Even though you never received cash, the fair market value of the television is generally taxable.
  
  
• Award Example: You receive a $2,500 award from a business association. Unless a special exclusion applies, that award is usually taxable.
  
  
• Gambling Example: You win $800 at a casino. That is generally taxable income, even if you immediately lose some of it back later. For gambling, the tax rules can be tricky because losses may be deductible only in certain circumstances and usually only up to 95% of the amount of winnings, and only if you itemize. So, be sure to keep records.
  
  
• Found Money is Taxable, But So is Property With Value: People sometimes assume cash is different from property. For tax purposes, it often isn’t. If you find:
  
  o   Cash,
  
  o   Jewelry,
  
  o   A watch,
  
  o   Gold,
  
  o   Collectible coins, or
  
  o   Other valuable items,

the fair market value may be taxable when you take possession, and it becomes yours.

Example: You find an antique watch in a park. A jeweler says it is worth $1,500. If you keep it and it is truly yours to keep, that $1,500 is generally part of your income. That is why “found money” stories can create tax issues.

Examples of Expressly Excluded Income

The tax code specifically excludes some types of income, some previously mentioned. This is not necessarily a complete list.

• Combat zone pay for qualifying military service in a combat zone.
  
  
• Military housing and subsistence allowances like BAH and BAS.
  
  
• Gain on the sale of a principal residence for qualified taxpayers, up to $250,000 for single filers or $500,000 for married couples filing jointly.
  
  
• Damages for personal physical injuries or physical sickness.
  
  
• Up to 14 days of rent from your home each year, sometimes called the “Augusta Rule.”
  
  
• Gifts you receive.
  
  
• Inheritances, but with certain exceptions.
  
  
• Life insurance death benefits.
  
  
• Qualified scholarship amounts used for tuition, fees, books, and required supplies.
  
  
• Certain welfare or general assistance payments from government programs.
  
  
• Qualified disaster relief payments.
  
  
• Child support.
  
  
• Alimony (for payments from divorce or separation agreements entered into or modified after Dec. 31, 2018)
  
  
• Municipal bond interest.
  
  
• Employer-provided health insurance premiums paid by your employer.
  
  
• Certain fringe benefits, such as de minimis fringe benefits.

Final Thoughts

IRC Section 61 is the broad starting point for income tax. It reaches almost every kind of economic gain, whether the money comes from a job, a business, a prize, or even something you found by chance. That is why even finding cash on the street or gold in a river can create taxable income.

But Section 61 is only the starting point. The tax law also contains important exclusions for gifts, inheritances, certain disaster relief, general welfare payments, and other special situations some, not all of which have been mentioned.

Whenever you have a question about whether an income item is taxed, you should contact this office. There may be certain steps that can be taken to minimize the tax effects or estimated taxes paid to avoid penalties.