Definition
Earned income refers to the money that an individual makes from employment or self-employment. This includes salaries, wages, tips, bonuses, and any other type of compensation for work performed. It is differentiated from unearned income, which is sourced from investments and other passive income channels.
Key Takeaways
- Earned income refers to money that an individual earns from working. It includes all wages, salaries, tips, or self-employment income that one gets as a part of one’s taxable income.
- The term ‘earned income’ is mainly used in the context of tax computations. Tax regulations often differentiate between earned income and unearned income, such as interest and dividends, for specific purposes such as determining eligibility for certain tax credits or deductions.
- The Earned Income Tax Credit (EITC) is a significant application of this concept. EITC is a refundable tax credit for low-to-moderate-income working individuals and couples, primarily those with children. The amount of EITC benefits is dependent on a recipient’s income and the number of children in the family.
Importance
Earned Income is an important financial term as it primarily refers to the money generated through employment or self-employment, such as wages, salaries, bonuses, commissions and profits from a business you run.
It’s crucial because it is considered taxable income under the revenue laws of many jurisdictions.
Furthermore, many government benefits and tax credits, like Earned Income Tax Credit (EITC) in the United States, are calculated based on earned income.
Often, it is the main source of income for individuals, and the ability to accurately measure and report it can affect a person’s tax obligations and eligibility for certain benefits.
Understanding your earned income is necessary for sound financial planning and management.
Explanation
Earned income refers to the money that is earned by performing work or through some business operations, and it is the primary means for most people to acquire wealth and finance their day-to-day living expenses. Essentially, earned income enables individuals to cover their basic needs and wants, including paying for housing, food, healthcare, and other necessities.
This is an integral part of the economy because it allows individuals to directly participate and contribute, through spending, saving, and investing, thus, driving economic growth and development. In terms of taxation, earned income plays an essential role as it is one of the key determinants of the amount of tax one owes.
It is used to calculate the Earned Income Tax Credit (EITC), a refundable tax credit for low to middle income working individuals and couples, particularly those with children. This is vitally important as it directly affects an individual’s after-tax income, potentially providing a substantial financial boost for those that qualify.
Therefore, by understanding and effectively managing one’s earned income, one can plan for a more secure financial future.
Examples of Earned Income
Job Salary: This is the most common form of earned income. For example, if you are employed by a company as a software engineer and you receive a monthly salary, this is considered as earned income. This can be reported annually for tax purposes.
Freelance/Consulting Work: If you work as a freelance writer or an independent consultant, the fees that you receive from your clients constitute earned income. For example, if you provide marketing consultation to five different firms and they all pay you a certain fee for your services, this payment is considered earned income.
Tips/Commission: For people working in positions like waitressing, bartending or sales, the tips or commission they earn for their service are part of earned income. For example, a real estate agent who sells a house and receives a percentage of the sale price as commission, this commission is considered earned income.
Earned Income FAQ
Q1: What is earned income?
A1: Earned income refers to money that is earned from working or self-employment. It includes wages, salaries, bonuses, commissions, and business income.
Q2: What is considered as non-earned income?
A2: Non-earned income includes things such as interest from savings, dividend from investments, gifts, pensions, social security benefits, and other types of passive income.
Q3: Is earned income taxable?
A3: Yes, in most cases, earned income is taxable. However, the amount of tax can be affected by various factors including the individual’s tax bracket, total income, and any potential deductions or credits they could be eligible for.
Q4: How does earned income impact my tax returns?
A4: Earned income might make you eligible for certain tax credits including the Earned Income Tax Credit (EITC), which could increase your tax refund or decrease the amount of tax owed.
Q5: How is earned income different from unearned income?
A5: The main difference between earned income and unearned income lies in their source. Earned income is generated from services you provide or work you do, while unearned income comes from sources where you are not actively involved, such as investments or rental properties.
Related Entrepreneurship Terms
- Gross Income
- Net Income
- Income Tax
- Passive Income
- Disposable Income
Sources for More Information
- Internal Revenue Service (IRS): The IRS offers comprehensive information about earned income and how it affects your tax filings.
- Investopedia: This financial education website provides clear, extensive definitions and explanations of a number of financial terms, included earned income.
- NerdWallet: NerdWallet is known for providing financial advice and explanations in layman’s terms. You can find valuable information on earned income here.
- TurboTax by Intuit: TurboTax is used by many to file taxes, and therefore it offers definitions and explanations about many finance and tax related terms like earned income.
