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Income Basket Definition
The US tax code defines an Income Basket as a taxable source of income from either active, passive, or portfolio gains. For e.g., monthly salary would be taxed under the Active Income Basket, while rent from a property would be taxed under the Passive Income Basket. Profits accrued on trading accounts would be taxed under the Portfolio Basket. Losses made in one basket cannot offset gains in another basket. Income Baskets help taxpayers track their gains and losses easily.
A Little More on What is an Income Basket
Let’s say ‘X’ has a salary of $60,000 per annum. X invests $6000 in a business venture. Due to various reasons, the ROI on this amounts to $3000 at the end of the year. X’s net loss for the year stands at $3000. So the total taxable income amounts to $57,000. This amount would be taxed under the Active Income Basket with the losses accounted for. The Active Income Basket also includes business profits, commissions, tips, wages for services rendered, and so on.
The Passive Income Basket is the taxable income that was made without any efforts or investments in the current financial year. E.g., royalties from a music catalog, rented money from a house that was bought long before the beginning of the current financial year that tax is being paid for, or income as a sleeping partner of a business venture. The taxpayer derives this income without having any financial or operational commitments to the source of this income.
Portfolio Income Basket includes profits made in stocks, options, dividends, capital gains and interest. Investment made in properties with the sole purpose of receiving royalties is also taxed as Portfolio Income.
How Income Baskets Benefit The Treasury
The Internal Revenue Services (IRS) find Income Baskets immensely helpful in identifying and blocking tax fraudulent tax reports. Since gains and losses are taxed separately for each basket, taxpayers cannot get away with rewriting losses made in the Portfolio Basket towards profits made from rented property. Taxes will be deducted separately for profits in the Active Income Basket, and losses will be written off only for the investments made in the Portfolio Basket. If all different sources of income were taxed as one, it would be really difficult to detect fraudulent tax reporting.
References for Income Baskets
Academic Research for Income Basket
- Tracking the middle-income trap: What is it, who is in it, and why?, Felipe, J., Abdon, A., & Kumar, U. (2012). This paper defines Middle-Income Trap, its causes and implications for countries stuck at this income threshold. It compares the economies of Korea, Malaysia and Philippines as examples of countries that have graduated this phenomenon and those that haven’t.
- A model of innovation, technology transfer, and the world distribution of income, Krugman, P. (1979). Journal of political economy, 87(2), 253-266. This paper defines Innovation and its impact on development of the economy by creating a model of product cycle trade.
- Income maintenance in old age: What can be learned from cross-national comparisons, Smeeding, T. M. (2001). (No. 263). LIS Working Paper Series. This paper looks at the effectiveness of anti-poverty measures and reforms in the Social Security System for maintenance of income in old age in developed countries.
- Access to healthy foods: part I. Barriers to accessing healthy foods: differentials by gender, social class, income and mode of transport, Caraher, M., Dixon, P., Lang, T., & Carr-Hill, R. (1998). Health Education Journal, 57(3), 191-201. This paper takes a look at the issue of access to a healthy diet and what dictates people’s choices when shopping for food. The findings shed light on the class and income divide that act as barriers to better eating habits.
- Consumption insurance: An evaluation of risk-bearing systems in low-income economies, Townsend, R. M. (1995). Journal of Economic perspectives, 9(3), 83-102. This book discusses risk taking behaviour in low income households in developing economies with studies conducted on formal and informal financial systems in South India, Thailand and other countries.
- The meaning and measurement of poverty, MacPherson, S., & Silburn, R. (1998). Poverty: A persistent global reality, 1-19. This book takes a closer look at poverty, different measures and indices to define and explain it, and its occurence in developed and developing nations.
- Global income inequality, Milanovic, B. (2006). WORLD ECONOMICS-HENLEY ON THAMES-, 7(1), 131. This paper sheds light on income inequality between various nations across the globe, inequality of mean incomes divided by the size of the population, and individual income inequality.
- The wealth of nations revisited: Income and quality of life, Diener, E., & Diener, C. (1995). Social Indicators Research, 36(3), 275-286. This book discusses the correlation of wealth to quality of life with a study of 101 nations across 32 indices.
- The additional costs of organic food products–A basket of goods-based analysis differentiated by income, Held, B., & Haubach, C. (2017). management revue, 28(1), 6-61. This book demonstrates, with the help of a statistical model based on the Laspeyres price index, the disparity between the cost of producing organic foods and the net income of consumers, establishing the fact that access to organic food is unaffordable for most households.
- From income inequality to economic inequality, Sen, A. K. (1997). Southern Economic Journal, 64(2), 384-401. This journal outlines the difference between income inequality and economic inequality, with the latter having a much broader scope and impact than the former.