Understanding Earned Income and the Earned Income Tax Credit

What Is Earned Income?

Earned income is money received as pay for work performed, such as wages, salaries, bonuses, commissions, tips, and net earnings from self-employment. It can also include long-term disability, union strike benefits, and, in some cases, payments from certain deferred retirement compensation arrangements.

Earned income can be contrasted with unearned income, also known as passive income, which is money not acquired through working.

Key Takeaways

  • Earned income is any income received from a job or self-employment.
  • Earned income may include wages, salary, tips, bonuses, and commissions.
  • Income derived from investments and government benefit programs would not be considered earned income.
  • Earned income is taxed differently from unearned income.
  • Employed taxpayers with lower incomes may be eligible for an earned income tax credit (EITC).

Understanding Earned Income

For tax purposes, earned income is any income you receive for work you have done for an employer or a business of your own.

Examples of income that isn’t considered earned include government benefits, such as payments from the Temporary Assistance for Needy Families program (often referred to as welfare), unemployment, workers’ compensation, and Social Security. Also excluded are disbursements from non-deferred pensions and retirement plans, alimony, capital gains, interest income from a bank account, stock dividends, bond interest, passive income generated from rental property, and salaries paid to inmates who work in a penal institution.

Both earned and other types of income are generally taxable, although sometimes at different percentage rates. For example, in the 2022 and 2023 tax years, the federal government taxes earned income at seven separate rates (or brackets), ranging from 10% to 37%. The thresholds tend to rise yearly to account for inflation and differ for single filers, married couples filing jointly, and heads of households.

Long-term capital gains on assets held for a year or more (classified as portfolio income) are taxed at 0%, 15%, and 20%, depending on the amount and the taxpayer’s filing status. In contrast, short-term capital gains, which cover assets held for less than a year, are taxed at the same rate as a taxpayer’s earned income.

Special Considerations

Determining whether income is earned or unearned—and reporting it on the appropriate lines of a Form 1040 or other tax return—is relatively straightforward. For some taxpayers, however, other ramifications of earned income are worth considering.

If you are receiving Social Security benefits, for example, you may have to pay income tax on a portion of those benefits if you have earned income (or other income) over a certain threshold. In that case, up to either 50% or 85% of your benefits will be subject to tax, depending on your income and filing status. This can be an important consideration for people who plan to continue working after they are eligible for Social Security benefits or are deciding whether to delay filing for benefits.

If you are self-employed, you also need to consider how much earned (and other) income you expect to have for the year and pay estimated taxes each quarter based on that amount. If you fail to pay enough tax throughout the year, you’ll have to make it up when you file your tax return, and you also may be subject to Internal Revenue Service (IRS) penalties.

Having earned income can affect whether a retiree’s Social Security benefits are taxable.

Earned Income Tax Credit (EITC)

If you have a relatively low earned income and meet other qualifications, you may be eligible for the federal earned income tax credit (EIC or EITC), which can reduce your tax bill or result in a refund. To qualify for the credit, you must file a tax return even if you don’t owe any tax or otherwise wouldn’t be required to file one.

The EITC was conceived as a type of “work bonus plan” to supplement the wages of low-income workers, help offset the effect of Social Security taxes, and encourage work to move people off welfare. It continues to be viewed as an anti-poverty tax benefit aimed to reward people for employment.

The EITC cap for 2022 is $560 for childless households; $3,733 for households with one child; $6,164 for those with two children; and $6,935 ($7,430 in 2023) for those with three or more children.

As usual in these matters, if you are unsure whether you qualify or have questions about your specific situation, seek advice from the IRS or an independent tax expert.

What Are Some Common Examples of Earned Income?

According to the Internal Revenue Service (IRS), earned income only includes money received as pay for work performed. Earned income includes only wages/salary, commissions, bonuses, and business income (minus expenses if the person is self-employed).

What Are Some Examples of Unearned Income?

Unearned income includes interest from savings, certificates of deposit (CDs), or other bank accounts, bond interest, alimony, capital gains, and dividends from stock. Income from retirement accounts, Social Security benefits, inheritances, gifts, welfare payments, rental income, lottery or gambling winnings, and annuities are all also classified as unearned income.

What Is the Difference Between Earned and Unearned Income?

Aside from the differences in how the income is generated (i.e., earned through working or not), the IRS may treat each differently for tax purposes. Tax rates vary among sources of unearned income; most unearned income sources are not subject to payroll taxes, and none of them are subject to employment taxes such as Social Security and Medicare. Additionally, unearned income cannot be used to contribute to a qualified retirement account such as an IRA.

Article Sources
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  1. Internal Revenue Service. “Publication 596: Earned Income Credit,” Pages 7–8.

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

  3. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."

  4. Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”

  5. Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.”

  6. Internal Revenue Service. “Publication 915: Social Security and Equivalent Railroad Retirement Benefits,” Page 6.

  7. Internal Revenue Service. “Publication 505: Tax Withholding and Estimated Tax,” Page 22.

  8. Social Security Administration. “Retirement Benefits: Income Taxes and Your Social Security Benefit.”

  9. Internal Revenue Service. “Earned Income Tax Credit (EITC).”

  10. Congressional Research Service. “The Earned Income Tax Credit (EITC): An Economic Analysis.”

  11. Internal Revenue Service. "Earned Income and Earned Income Tax Credit (EITC) Tables."

  12. Internal Revenue Service. “Unearned Income.”

  13. Internal Revenue Service. “Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).”

  14. Govinfo. “26 U.S.C. (United States Code): Subtitle C—Employment Taxes: Chapter 21—Federal Insurance Contributions Act: Subchapter A—Tax on Employees: Section 3102—Deduction of Tax from Wages.”

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