Gross Income vs. Earned Income: An Overview
The distinctions between earned income and gross income are especially important to understand in relation to tax accounting. Report either one incorrectly and you could end up paying more in taxes than you really need to.
Gross income is everything that an individual earned during the year, both as a worker and as an investor. Earned income includes only wages, commissions, and bonuses, as well as business income, minus expenses, if the person is self-employed.
According to the U.S. Internal Revenue Service (IRS), gross income is defined as all facets of income an individual has received throughout any given year. Gross income includes all the same measures that constitute earned income—namely, wages or salary, commissions, and bonuses, as well as business income net of expenses if the person is self-employed. However, gross income also includes investment income in the form of interest and dividends, as well as retirement income derived from retirement account withdrawals. Additionally, gross income includes Social Security benefits, as well as Social Security disability benefits, unemployment payments, alimony, and child support.
According to the IRS, earned income includes certain earnings over the course of any given year, as defined previously, but not investments. Earned income may also include the fair market value of certain fringe benefits that are deemed taxable through an employer under the direction of the IRS guidelines, long-term disability benefits received prior to minimum retirement age, and strike benefits from involvement in union activities. Earned income does not include the same range of income that is accounted for under the purview of gross income.
Prior to filing a tax return, it is important to understand the differences between gross income and earned income. Other commonly used tax terms individuals should understand include adjusted gross income (AGI) and modified adjusted gross income (MAGI). Each of these is used in a different way to determine total taxable income and, ultimately, your total tax obligation based on your net income for the year.
Gross income is considered total income for the purpose of tax preparation and filing, and it is used to further determine total tax liability. This figure is also the starting point for calculating adjusted gross income, which is your income after deductions, and modified adjusted gross income, which is similar to adjusted gross income but with certain deductions added back to the total.
The IRS uses your earned income total to determine whether certain financial actions can be taken throughout the year. For instance, you can contribute to an individual retirement account only if you have earned income for the year, and that contribution may not exceed your total earned income for that year.
[Important: Your gross annual income is used to determine what deductions, exemptions, and credits are available to you to determine your total taxable income and then your total tax obligations for the year.]
Earned income, gross income, adjusted gross income, and modified adjusted gross income provide the foundation for tax preparation and filing. The difference between earned income and gross income is an important one in your tax accounting.
- Gross income is everything earned during the year, as a worker and as an investor.
- Earned income includes only wages, commissions, and bonuses, as well as business income, minus expenses, if the person is self-employed.
- Gross income and earned income, along with adjusted gross income and modified adjusted gross income, are crucial for tax preparation and filing.