What Is Earned Income?

How Does Earned Income Work?

Generally, earned income is any money your employer pays you for your labor, any sales generated from a business you own, or monetary profit from self-employment.

In contrast, unearned income is typically money made where the relationship between work and earnings is not as direct. Unearned income can include interest and dividends from investments, pensions, annuities, unemployment benefits, alimony, and child support.

Both earned income and unearned income are taxable by the IRS. However, the tax implications are different for each type of income. For earned income, which you can make in a variety of ways, including your job, the following taxes apply:

If you don't make money that way, but instead make money from investing or dividends, you'll get taxed at the capital gains tax rate, which is much lower.

Examples of Earned Income

The Internal Revenue Service (IRS) classifies earned income as any taxable income you obtained from working your hourly or salaried job and revenue gained from self-employment. It's taxed differently from certain types of unearned income, such as capital gains.

Consider this hypothetical example of earned income. Johnny made $60,000 from working his salaried position as an accountant, and he also owned a side business selling T-shirts, which generated $40,000 in revenue that year. So Johnny would need to report $100,000 ($60,000 + $40,000) on his tax returns as earned income, prior to taking any deductions.

Tax Credits for Earned Income

There are tax credits available to exclude a portion of your taxable earned income, thus reducing your total tax liability. These tax credits include the Earned Income Tax Credit (EITC) and Student Earned Income Exclusion.

Earned Income Tax Credit

The EITC is a tax credit available to taxpayers in a lower tax bracket. It can reduce the amount of tax owed to the government and may even issue a refund to qualified taxpayers. The credit amount will vary based on the number of your dependents and your income.

Student Earned Income Exclusion

The Student Earned Income Exclusion is available for blind or disabled students who are under the age of 22. In 2022, they could exclude $2,040 each month, up to a yearly maximum of $8,230, and not have it count against their Supplemental Security Income (SSI) benefits. In 2023, they can exclude $2,220 each month, up to a yearly maximum of $8,950.

To qualify, students had to be regularly attending school, which could include middle school, high school, college, trade school, or some types of employment training.

Types of Earned Income

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

• Wages, salaries, and tips: Monetary compensation paid to you by your employer. Any tips gained while working your job, such as tips a server earns at a restaurant, is also considered earned income.
• Self-employment earnings: If you own a business or work as an independent contractor, the money you make is considered earned income. The IRS includes earnings obtained as a minister or member of a religious order in the self-employment category.
• Royalties: Regular payments in relation to the publication of a work, such as a book or a song, are classified as earned income.
• Honorarium: An honorarium is payment for services or activities unrelated to your designated responsibilities. This may include payment for speaking at an event, writing an article, or participating in a convention, as well as reimbursement for your travel lodging and meals.
• Union strike benefits: Any payments received as benefits from a union strike must be included when reporting your income.
• Long-term disability benefits: If you claim disability retirement benefits before reaching the minimum retirement age, those benefits may qualify as earned income.

Frequently Asked Questions (FAQs)