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What Is Earned Income and How Is It Calculated?

4 min read

Published December 3, 2024

Table of contents

Key Takeaways

Earned income includes all the money you earn from working for another company, yourself, or a business you own.
Investments, rental payments, alimony, and other passive sources of income don’t count toward earned income.
Certain low- to moderate-income workers may qualify for the Earned Income Tax Credit, which could reduce the amount of income taxes they owe.

Your household income may come from various sources, like your paychecks, earnings from side jobs, and family gifts. While those different income sources may help you reach the same goals, the Internal Revenue Service (IRS) categorizes them differently. Even if you're self-employed, the money you earn from working is considered “earned income”. The differences between income types may seem confusing at first. However, understanding earned income could help you manage your income taxes and identify credits.

Earned income definition

Earned income includes many types of pay. Unlike gross income, earned income excludes passive income, like investments and rent. Basically, any taxable income you receive from any kind of job counts towards your “earned income”.

The IRS explains that earned income includes money you receive from your job, self-employment, freelancing, or your small business. Salaries, gig economy earnings, and net business or farm profits generally qualify.

The IRS provides these examples of earned income, as well as more:

Wages
Salaries
Tips
Union strike benefits
Money from self-employment
Some long-term disability benefits claimed before retirement age

What is unearned income?

Unearned income generally includes money you receive through a source outside of work. Some examples of “unearned income” include the following:

Child support payments
Alimony payments
Social Security benefits
Unemployment benefits
Pay for work while incarcerated
Interest and dividends from stock
Pensions or annuities

How is earned income calculated?

As earned income is “the taxable income and wages you get from working for someone else, yourself or from a business or farm you own”, according to the IRS, you calculate it by adding up your taxable income and wages for the year. The IRS also provides tools for calculating your earned income as you file your taxes.

Did you know?

Your income is one of the factors credit card issuers assess when determining if you qualify for a credit card. Along with income, issuers may factor in your credit history and your debt-to-income ratio in the application approval process. If you’re applying for a new credit card, keep these things in mind.

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What is the earned income tax credit?

The earned income tax credit (EITC) is a refundable tax credit to help working families with low or moderate earned income, according to the IRS. It may help you save money on your tax bill or even get a refund. If you believe you qualify for the EITC, you can claim it on your tax return.

How do you qualify for the earned income tax credit?

American citizens with low-to-moderate income may benefit from the federal EITC. According to the IRS, to qualify for the EITC, you need a valid social security number; an individual taxpayer identification number (ITIN) isn’t accepted. Your filing status, children, income level, and investments all affect your eligibility.

Both single and married workers may qualify for the EITC benefit, according to the IRS. However, the way they file their taxes matters. To qualify, you have to file as Single, Head of Household, Qualifying Widow or Widower with Dependent Child, or Married Filing Jointly.

Qualifying children in your care may increase your credit, according to the Internal Revenue Service. However, childless workers between 25 and 65 may be eligible if they meet certain requirements.

The federal EITC’s income limits may change each tax year and depend on your household’s characteristics. While investments don’t automatically disqualify you, annual investment income has an established limit each tax year.

While these guidelines may offer you an idea of your eligibility, every situation is different. For more information, check the IRS website or speak with a tax professional.

Your income may come from a wide range of sources. However, understanding the differences between what is earned income and unearned income could pay off for you and your family during tax season.

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