Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate acts is less than it otherwise would be.

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A taxpayer’s characterization of the source of income is one of the ways in which a taxpayer may order his affairs.  However, it should first be noted that not all monies taken in by a taxpayer in a year are considered income, or therefore subject to taxation.

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To be considered income (from a source), the amount should be able to be linked with one or more of the following characteristics:

• recurrence on a periodic basis;
• involving organized effort, activity, or pursuit on the part of the taxpayer;
• giving rise to an enforceable claim to the payment by the taxpayer;
• payment was sought after and/or reasonably expected by the taxpayer;
• the payer is a customary source of income for the taxpayer;
• involving a marketplace exchange; or
• the pursuit of profit.

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Once the amounts taken in by the taxpayer have been affirmatively characterized as income from a source, depending on the characterization of the source from which the amounts flowed, the income may lead to the availability of different deductions, remittance time requirements, and possibly even different taxation rates.

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Broadly speaking, sources of income can be characterized in two ways: either as being from office or employment, or as being from business or property. The first step requires knowing whether the relationship between the taxpayer and the source is one of a contract of service, which creates an employer-employee relationship, and results in the source of the income being characterized as derived from office or employment, or whether the relationship is one of a contract for services, which creates the relationship of a principal and agent, and results in the source of income being characterized as derived from business or property.

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While both characterizations ultimately result in the income being taxable, the characterization, and the corresponding deductions available, may result in different taxpayers reporting different values of their income from a source for the year, even though the gross amounts taken in may have started off as being the same to each of them.

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