Income Basket

An income basket is a category of income as defined by the U.S. tax code. Each category, or basket, represents a different source of income. Baskets may operate at a net gain or a net loss individually. However, a loss in one basket may not be used to offset taxable gains from another.

One income basket defined by the IRS is passive income. Passive income includes rent collected on rental properties, dividends, royalties and gains from sales and exchanges of securities. Another basket is general income. General income includes wages and salaries as well as any income gained through active participation in a business. Category 901(j) is another basket that specifically applies to those seeking the foreign tax credit.

Income baskets can help taxpayers to understand which sources of income are providing them with gains and which with losses. Without the use of baskets, this process can be more difficult.

For example, a person may have a regular salaried job that pays them $40,000 per year. They don’t take any losses on that job, because any expenses they incur are paid for by the company they work for. However, this person has also decided to invest their money in a small business startup to earn some extra money. They invest $10,000 in the startup. In the startup’s first year, the business grosses $10, 000. However, there were a lot of upfront costs to get the business started, so the company is only able to pay back investors $5,000 this year. The taxpayer had a net loss of $5,000 on that investment this year. At the end of the year, this taxpayer has had a net income of $35,000. This represents their salary minus the loss from the investment.

Overall, the taxpayer made money this year. However, if they wanted to look at their finances to assess where their money comes from and how to make more money next year, they can look at the returns on their baskets individually. If they did this, they would see that their general income netted them $40,000, while their investment in a startup had a net loss of $5,000.

Income baskets help prevent taxpayers from avoiding taxes by reporting excessive losses on certain revenue streams. This can be seen through the above example. This taxpayer had a net income for this year of $35,000. However, in one basket, they had a net income of $40,000, while in the other, they had a net loss of $5,000. When it comes time to file their taxes, they will need to pay income tax on that $40,000. They will not need to pay taxes on their investment, since it netted a loss. However, without the use of income baskets in the tax code, this person would be filing taxes on a $35,000 annual income, not a $40,000 income.