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Level 2. Income & Taxes

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Level 2. Income & Taxes

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About this activity

Learn how the different income types are structured for tax purposes

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WM
WM
United States

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Level 2. Income & Taxes
 

Level 2. Income & TaxesOnline version

Learn how the different income types are structured for tax purposes

by WM
1

Income Types & Taxes

You've learned how money can come from many different sources, and you've also learned how taxes work. In this activity, you'll see how the two are connected when it comes to paying taxes on the money you receive. Pay close attention as you go along to see if you can spot the pattern.

2

Hourly Income

How it's taxed: Automatically withheld

How often: Every paycheck

What's taken out:

  • Federal tax
  • State tax
  • FICA tax

Good to know: Your employer handles the taxes before you get paid

3

Salary Income

How it's taxed: Automatically withheld

How often: Every paycheck

What's taken out:

  • Federal tax
  • State tax
  • FICA tax

Good to know: Pay is consistent, so taxes are usually predictable

4

Tip Income

How it's taxed: Manually reported + automatically withheld (A server will report their tip income every pay period, and taxes will automatically be taken from the paycheck)

How often: Every paycheck

What's taken out:

  • Federal tax
  • State tax
  • FICA tax

Good to know: Tips are taxable, even if they are paid in cash

5

Commission Income

How it's taxed: Automatically withheld

How often: Whenever commission is paid

What's taken out:

  • Federal tax
  • State tax
  • FICA tax

Good to know: The larger the commission check, the higher the tax withholding

6

Freelance/Gig Income

How it's taxed: Handled manually

How often: Usually quarterly and/or yearly

What's taken out: Nothing. There is no automatic withholding

Good to know: Money must be set aside from the income earned to pay taxes when they are due

7

Business Owner Income

How it's taxed: Handled manually

How often: Usually quarterly and yearly

What's taken out:

  • Self-employment tax (covers Social Security & Medicare
  • Income tax (covers federal and state taxes, if applicable)

Good to know: Business owners pay both the employee and employer portion of Social Security & Medicare (double taxes)

8

Unearned Income (Interest, Dividends, Royalties, Rental)

How it's taxed: Handled manually

How often: Yearly (Usually when you file taxes)

What's taken out:

  • Federal tax
  • State tax (if applicable)

Good to know: Unearned income is not subject to FICA tax (Social Security & Medicare)

9

Cash Gifts

How it's taxed: Tax-free

How often: Not applicable

What's taken out: Nothing

Good to know: Cash gifts are typically exempt from all taxes. It's literally just a gift

10

Can you spot the pattern?

Conclusion: If you didn't notice, the main takeaway here is that taxes are usually handled one of two ways. Income that is earned from an employer (hourly, salary, tipped, commission) has taxes automatically withheld before you receive your paycheck. This ensures simplicity and relieves you of responsibility. Income that is earned on your own (business, freelance, and unearned income) requires you to manually pay taxes. This structure increases your responsibilities. You must plan accordingly and maintain an accurate tracking of your income throughout the year in order to avoid penalties and legal issues.

Good to know: It's safe to assume that any money you make will usually require some type of tax to be paid on it.
 
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