What is Earned Income?
Earned income includes wages, salaries, bonuses, commissions, tips and net earnings from self-employment. It can also include long-term disability and union strike benefits and, in some cases, payments from certain deferred retirement compensation arrangements.
- Earned income is any income from a job or self-employment.
- Income from investments and government benefits is not considered earned income.
- Taxpayers with low incomes may be eligible for an Earned Income Tax Credit.
Understanding Earned Income
For tax purposes, earned income is any income that a person receives for work they have done, either for an employer or for a business of their own.
Examples of income that isn’t considered "earned" would include benefits such as Temporary Assistance for Needy Families (often referred to as welfare), unemployment, workers' compensation, and Social Security. Also in this category are disbursements from non-deferred pensions and retirement plans, alimony, capital gains, interest income from a bank account, stock dividends, bond interest and passive income generated from rental property.
Both earned income and other types of income are generally taxable, although sometimes at different percentage rates. For example, as of 2019 the federal government taxes earned income at seven separate rates (or brackets), ranging from 10% on the first $19,400 in income for married couples filing jointly to 37% for any income over $612,350, again for married couples filing jointly. The thresholds are different for singles, married couples who file separately, and heads of households.
However long-term capital gains, on assets held for a year or more, are taxed at 0%, 15% and 20%, depending on the amount and the taxpayer's filing status. Short-term capital gains, on assets held for less than a year, are taxed at the same rate as the taxpayer's earned income.
Having earned income can affect whether a retiree's Social Security benefits are taxable.
Special Considerations for Earned Income
Determining whether income is earned or unearned—and reporting it on the appropriate lines of a Form 1040 or other tax return—is a relatively straightforward process. For some taxpayers, however, earned income can have ramifications that are worth taking into consideration.
For example, anyone who is receiving Social Security benefits may have to pay income tax on a portion of those benefits if they have earned income (or other income) over a certain threshold. In that case, as much as 50% or 85% of their benefits will be subject to tax, depending on their income and filing status. This can be an important consideration for people who plan to continue working after they file for Social Security benefits or are deciding whether to delay filing for benefits.
Many self-employed taxpayers also need to consider how much earned (and other) income they expect to have for the year and pay estimated taxes each quarter based on that amount. Taxpayers who fail to pay enough tax throughout the year can be subject to IRS penalties.
Taxpayers with relatively low earned incomes—and who meet other qualifications—may be eligible for the federal earned income [tax] credit (EIC), which can reduce their tax bill or result in a refund. To qualify for the credit, they must file a tax return even if they don't owe any tax or wouldn't otherwise be required to file one.
As usual in these matters, anyone who is unsure about whether they qualify or has questions about their specific situation should seek advice from the IRS or an independent tax expert.