What is earned income?

Definition: Earned income is any taxable income received from working in a job, self-employment, or certain specified government benefits.

How Does Earned Income Work?

Generally, earned income is any amount of money paid by an employer to you for your work, or the revenue you earn from self-employment, or financial profit from freelance work.

In contrast, unearned income is typically considered money earned without working, such as interest and dividends from investments, pensions, social security, family allowances, and cash assistance.

Both earned and unearned income are subject to taxation by the Internal Revenue Service (IRS). However, the tax implications for each type of income differ. For earned income, which you can earn in various ways, including your job, the following taxes apply:

Examples of Earned Income

The IRS classifies earned income as any taxable income you receive from work performed for a wage or salary, and the revenue you earn from self-employment. Taxes on earned income differ from those imposed on certain types of unearned income, like capital gains.

Example: Johnny’s earned income is a hypothetical example. Johnny earned $60,000 from his job as an accountant with a fixed salary, and he also had a side business selling T-shirts, which generated $40,000 in revenue that year. Therefore, Johnny will need to report $100,000 ($60,000 + $40,000) on his tax return as earned income before taking any deductions.

Tax Considerations for Earned Income

There is a tax credit that may allow you to exclude certain amounts from taxable earned income, thereby reducing your overall tax liability. This tax credit includes the Earned Income Tax Credit (EITC) and the exclusion of earned income for students.

Types of Earned Income

Here are some common examples of earned income, although this list does not encompass every type of earned income:

• Wages, salaries, and tips: Financial compensation paid by an employer to you. Any tips you receive while working, such as tips received by a waiter in a restaurant, are also considered earned income.
• Self-employment income: If you own a business or work as an independent contractor, the money you make is considered earned income. The IRS includes profits you earn as a minister or member of a religious congregation in the category of self-employment.
• Royalties: Payments received periodically related to publishing a work, such as a book or song, are classified as earned income.
• Fees: Fees are compensation for services or activities not related to specific responsibilities. This might include payment per word for a speaking engagement, writing an article, or participating in a conference, along with reimbursement for lodging and meals while traveling.
• Union strike benefits: Any payments you receive as strike benefits from a union must be included when reporting your income.
• Long-term disability benefits: If you claim retirement benefits due to disability before reaching the minimum legal retirement age, these benefits may qualify as earned income.

Frequently Asked Questions (FAQs)

What is earned income versus unearned income?

Earned income typically refers to the income you receive from work, including tips, hourly wages, and bonuses. Unearned income generally refers to income you receive without work, such as gifts, money from family, dividends, and interest payments. Generally, earned income is taxed by the federal and state government, while unearned income may not be taxed.

Is rent considered earned income?

Income you receive from renting properties is taxed as income, but it is considered passive income. This means that while you can take tax deductions on rental income, your deductions are likely to be limited based on your adjusted gross income and how actively you participate as a property owner.

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Sources:

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy, reliability, and quality of our content.

Internal Revenue Service (IRS). “The IRS Provides 2023 Inflation-Adjusted Tax Changes.”

Internal Revenue Service (IRS). “The IRS Provides 2022 Inflation-Adjusted Tax Changes.”

TurboTax. “Guide to Capital Gains Tax Rates: Short-Term vs. Long-Term Capital Gains Tax.”

Internal Revenue Service (IRS). “Earned Income and the Earned Income Tax Credit (EITC) Tables.”

Connecticut Department of Revenue Services. “What is Earned Income?”

Internal Revenue Service (IRS). “When to Expect a Tax Refund If You Claim the Earned Income Tax Credit or Additional Child Tax Credit.”

Social Security Administration. “Student Earned Income Exclusion from SSI.”

Social Security Administration. “SSI Spotlight on Student Earned Income Exclusion.”

Consumer Financial Protection Bureau. “Distinguishing Between Earned and Unearned Income.”

Source: https://www.thebalancemoney.com/what-is-earned-income-5213396