The words “principal” and “income” on an investment are usually assumed to have a clear and simple meaning. A man puts $1,000 of his principal into a savings deposit; during the year the bank credits him with $30 interest, and this is his income. If he buys 100 shares of corporate stock, those shares are his principal, and when the company pays him a dividend, that is his income. Traditionally, when a family de rives all or most of their income from investments and pensions, they are expected to spend their income but to leave their principal or capital intact. Unfortunately, when confronted with some of the queer facts of investing, these simple distinctions between principal and income get kind of blurred.

Income-Tea Rules

The Federal income-tax rules naturally affect an investor’s notions of what constitutes income. Mostly, those rules agree with the above definitions, the main question being on the proceeds from a sale of principal. When a depositor closes a savings account, the bank pays him exactly the same number of dollars that he deposited. If he left his interest on deposit, the bank has added that to his principal, but he is supposed to have reported that interest as taxable income. There is no question of a gain or loss in value of principal. Certified Financial Planner - Read More.