Earned Income

What is earned income?

Earned income is the money you receive as payment for work. It includes wages, salaries, bonuses, commissions, tips, and net earnings from self-employment. For tax purposes, certain other payments—such as long‑term disability paid before retirement age or union strike benefits—can also qualify as earned income.

Income from investments, most government benefits, and other nonwork sources is considered unearned income (or passive income) and is treated differently for tax and retirement‑account rules.

Key points

• Earned income = pay for work (employee or self‑employed).
• Unearned income = investment returns, most government benefits, pensions, annuities, etc.
• Earned and unearned income are taxed differently; payroll taxes apply to most earned income.
• Low‑ and moderate‑income workers with earned income may qualify for the Earned Income Tax Credit (EITC).

Examples of earned income

• Salaries and wages (hourly or salaried pay)
• Self‑employment income (freelancers, contractors, small business owners)
• Tips and sales commissions
• Performance bonuses and other contingent pay
• Honoraria for services (e.g., speaking fees)
• Certain long‑term disability payments claimed before retirement age

Examples of unearned income (not earned)

• Interest, dividends, capital gains
• Most Social Security benefits and unemployment benefits
• Pension and retirement plan distributions (non‑deferred)
• Rental income, annuities, inheritances, gifts
• Welfare and many government assistance payments

Tax considerations

• Federal income tax brackets apply to earned income; rates differ from capital gains rates.
• Payroll taxes (Social Security and Medicare) generally apply to earned income but not to most unearned income.
• If you receive Social Security benefits, having earned income can affect how much of those benefits are taxable—up to 50% or 85% may be taxable depending on total income and filing status.
• Self‑employed taxpayers must pay self‑employment taxes and typically make quarterly estimated tax payments to avoid penalties.
• Some retirement contributions (for example, making an IRA contribution in your own name) generally require earned income as the basis for the contribution.

Earned Income Tax Credit (EITC)

The Earned Income Tax Credit is a refundable federal credit designed to supplement wages for low‑ and moderate‑income workers and to encourage work. Key points:

• The EITC reduces tax liability and can produce a refund even if no income tax was withheld.
• Eligibility and credit amount depend on filing status, earned income, and number of qualifying children; income thresholds and amounts are adjusted annually.
• To claim the EITC you must file a tax return—even if you do not owe tax.
• Basic eligibility requirements include: having earned income below the applicable threshold, a valid Social Security number by the return due date, U.S. citizenship or resident‑alien status for the entire year, and not filing Form 2555 (foreign earned income exclusion). Additional rules apply for separated spouses and qualifying children.

If you’re unsure whether you qualify, consult IRS guidance, tax software, or a tax professional.

Worked example

A taxpayer receives:
* Salary: $50,000
* Bonus: $10,000
* Side‑gig wages: $5,000
* Tips: $500
* Ordinary dividends: $1,000
* Capital gain distributions: $25,000

Earned income equals the pay for work: $50,000 + $10,000 + $5,000 + $500 = $65,500. Dividends and capital gains ($26,000) are unearned and are reported separately for tax purposes.

How to determine whether income is earned

Ask whether the payment was compensation for actual work or services. If yes, it’s likely earned income. If it derives from ownership, investment, or government assistance, it’s likely unearned. When in doubt, consult IRS guidance or a tax professional.

Frequently asked questions

Q: Do investment returns count as earned income?
A: No. Interest, dividends and capital gains are unearned income.

Q: Can unearned income be used to make IRA contributions?
A: Generally no. IRA contributions in your name typically require earned income as the basis (exceptions include spousal IRAs).

Q: Do I need to file a return to claim the EITC?
A: Yes. You must file a tax return to claim the EITC even if you owe no tax.

Q: Are tips and commissions taxable?
A: Yes—tips and commissions are earned income and are taxable.

Conclusion

Earned income is pay received for work and is treated differently from unearned income for tax and retirement‑account purposes. Know which of your payments qualify as earned income—especially if you’re self‑employed, receiving Social Security, or may be eligible for the EITC—to ensure correct reporting and tax treatment.