What is Earned Income?

Mary McMahon

Earned income is income earned from work. If someone works at a lemonade stand and receives money for it, for example, this would be earned income. This is in contrast with unearned income. To borrow the lemonade stand example again, if someone invested in a lemonade stand and received dividends, these dividends would be considered unearned income because they were not the result of work. Earned and unearned income are treated differently for tax purposes.

The lemonade stand worker makes earned income while selling.
The lemonade stand worker makes earned income while selling.

A number of different types of compensation can fall under earned income. All income from wages, salaries, and tips is part of someone's earned income. Likewise, disability benefits are sometimes treated as income for tax purposes as long as someone is below retirement age. Profits from self employment are earned income, and in some regions of the world any benefits paid out by a union to striking workers are also taxed as income.

A person's earned income for a given year can be found on her W-2 forms.
A person's earned income for a given year can be found on her W-2 forms.

By contrast, things like rents received, interest, capital gains, and dividends are unearned income. While these monies are indisputably income, the recipient did not work for them. Usually tax forms provide clear descriptions for each field so that people can be assured that they are documenting their income correctly. If someone is confused about where on a tax form a given piece of information about income needs to be disclosed, an accountant or tax attorney can be consulted for more information.

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Tax benefits like the Earned Income Tax Credit (EITC) in the United States are based on earned income, and earned income is also usually taxed at the base income tax rate. Taxpayers are also entitled to take deductions when filing their taxes to reflect expenses incurred over the course of the year. Not every expense is tax deductible and there can be penalties for claiming expenses which do not legally count as deductions.

There are several ways in which people may document their earned income. Employers are usually required to send out annual disclosures documenting how much they paid to their employees. Employees can also keep paystubs and use them as records of earned income. It is advisable to keep track of pay over the course of the year and to check one's own figures against those provided in an employer's income disclosure statement for the purpose of confirming that it is correct. If the figures do not agree the statement should be amended to reflect the right figures and refiled.

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