What Is Earned Income?

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All taxable earnings that an individual generates in exchange for some work done are earned ones, including payments received for disabilities. However, an income is said to be earned only when the monetary benefits are received from employment, be it regular, inactive, or business ownership, and those are a part of the gross income.

Key Takeaways

  • Earned income refers to the income by the person, which can be the amount of salary, wages or employee compensation, etc., received from the employer during the employment or the income by an individual from their own business.It refers to all the income earned from inactive employment, gross income, or business running.The Earned Income Tax Credit (EITC) is a type of tax rebate/credit made available to those whose earned amount is below a certain threshold, as decided by the IRS every year.Such income includes all monetary benefits one receives for the work done, involving personal efforts, and doesn’t include anything obtained without effort, such as dividends, gifts, etc.

Earned Income Explained

As the name implies, earned income is the income one earns and not just receives for anything. When a person works hard to earn money, it is the income earned, while the income generated without effort does not fall under the category of income earned. Per the Internal Revenue Service (IRS), such income includes wages or salary, commission, bonus, and business income after adjusting for expenses incurred to earn the same during the taxable year, which is usually the calendar year in the United States.

As per IRS guidelines, the following income forms its parts:

  • A person receives long-term disability benefits before the minimum retirement age.Benefits from strike received on account of involvement in union activities collectively called union strike benefits.Earnings or net of expenses received from rendering services as a minister or member of the religious community.Earnings (net of expenses) in the capacity of a statutory employeeRoyalties, commission, and tips as received

Some of the income that does not form part of earned income include:

  • The dividendDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more payments received from stocks and the interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more from bonds and depositsIncome received from retirementBenefits accrued on account of unemploymentSocial Security Benefits such as pension or annuity paymentsThe alimonyAlimonyAlimony is court-ordered financial support given to a spouse in case of divorce or separation and is given to the spouse with a lower level of income or no income at all.read more and child support benefits

Tax Credits & Implications

The Earned Income Tax Credit (EITC) is a type of tax rebate/credit made available to those whose earned income is below a certain threshold, as decided by the IRS every year. Thus, to register a claim, the earners need to have an income earned with a specific adjusted gross income (AGI) and credit limits per the tax years, be it current, previous, or next.

In addition, the Social Security Number (SSN) is a must for an individual to obtain EITC, as the details are required for all spouses and dependent qualifying children to enjoy rebates. The earned income credit deductions are provided based on the marital status of the person and the number of qualifying children.

Whether individuals file the tax credit or return jointly with their spouse or not, the exemption for dependent care expenses for qualifying children adjusts from the income. The concerned taxpayers must have been a citizen of the United States for not less than half a year from the year for which they claim such credit.

Examples

Let us understand the earned income definition better with the help of the below-mentioned examples:

Example #1

Riya works as a risk manager with Union Global and has earned the following income during the year:

  • Salary: $20000Bonus: $8000Income from providing part-time consultancy: $4000Stock dividends: $1200

Further, Riya also received:

  • Alimony worth $5000 from her separationInterest on bonds amounting to $3000

For calculation, the following income will be added:

On the other hand, other incomes received by Riya were not included in the calculation.

Example #2

Katherine decided to file an EITC claim after the death of her husband in 2022. Thus, she researched the details to know the limits and amount she was eligible to claim. Here is what she came across:

For the tax year 2022, however, the investment income limit as decided by IRS authorities was $10,300 or less, and the maximum credit amount per that was:

  • No qualifying child = $5601 qualifying children = $3,7332 qualifying children = $6,1643 or more qualifying children = $6,935

Earned Income vs Unearned Income

While earned income includes all income generated or received in return for the work an individual performs or services an entity offers, unearned income is anything that is received without putting in any effort. For example, if a person receives gifts in cash or wins the prize money, such earnings fall under unearned earnings. The latter’s nature is also referred to as a passive income.

Besides that, the IRS also differentiates between them based on their tax purposes. For example, the tax levied on the sources of earned and passive income differs hugely. While none of the unearned earnings are subject to employment taxes, like Medicare, Social Security, etc., most remain exempt from payroll taxes.

Unlike earned income, unearned money cannot be used to contribute to retirement schemes.

This has been a guide to What is Earned Income & its definition. Here, we explain earned income tax credit concept with examples and its comparison with unearned income. You may learn more about it from the following articles –

No, pensions are not considered an income earned. It is because the recipients receive this money post their employment tenure. Therefore, the pension is the reward for an employee’s tenure of employment or service, not the income received in return for the work being done under an employment contract.

It is calculated based on the IRS’s specifications for a particular financial year – current, past, or next. The marital status and qualifying number of children for the claim are two main factors based on which the EITC can be calculated.

An income earned includes all kinds of earnings received from employment, given they are all included in the gross income. Some examples here include salaries, wages, tips, bonuses, etc.

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