Any money given to you for work that you have done is termed earned income. As an example of money that is not considered to be earned income, if your employer advanced you money against your upcoming pay check, this would be unearned income. This is because you have not yet performed the work that earns the income.
It is generated in one of two different ways. You might work for a person or company that pays you for the work. Alternatively, you could work as a self employed person in a business that is yours.
For taxing purposes, earned income is a broader category. It involves not only salary, wages, and tips, or alternatively self employment net earnings, in the calculations of the IRS. They also include benefits from union strikes and benefits for long term disability that are earned before a person achieves the minimum retirement age as unearned income. Combat pay for military personnel is not usually considered to be taxable earned income either.
There are various forms of income that are considered to be unearned income, or not earned. These include investment returns, such as dividends, interest, and capital gains. Social security and unemployment benefits are also unearned income. Finally, pensions, child support, and alimony are all not considered to be earned income.
It is not only used by the IRS to determine an individual’s tax liability for the current year. It is also employed to determine eligibility for the Earned Income Tax Credit, more commonly referred to by its acronym the EITC. This Earned Income Tax Credit proves to be a credit against taxes for individuals who work and receive low wages for their earned income.
Tax credits such as this one commonly translate to additional numbers of earned income dollars staying in the person’s pocket, or a lower tax liability for the year than would otherwise be anticipated. Not only does this decrease the amount of tax that might be owed, but it could lead to a tax refund if the adjusted gross income results in negative income tax being due.