Earned income is considered any taxable income obtained from working a job, self-employment, or certain government benefits. Earned income is taxed differently from certain types of unearned income, such as capital gains.
Learn more about earned income, how it works, and about its role in your taxes.
Definition and Examples of Earned Income
The Internal Revenue Service (IRS) classifies earned income as any taxable income you obtained from working your hourly or salaried job and revenue gained from self-employment.
In some cases, certain government benefits, such as some disability payments, may be considered earned income.
Consider this hypothetical example of earned income. Johnny made $60,000 from working his salaried position as an accountant in 2020, and he also owned a side business selling T-shirts, which generated $40,000 in revenue that year. So the total earned income Johnny made in 2020 would be $100,000 ($60,000 + $40,000).
How Does Earned Income Work?
Generally, earned income is any money your employer pays you for your labor, any sales generated from a business you own, or monetary profit from self-employment.
In contrast, unearned income is typically money made where the relationship between work and earnings is not as direct. Unearned income can include interest and dividends from investments, pensions, annuities, unemployment benefits, alimony, and child support.
Both earned income and unearned income are taxable by the IRS—however, the tax implications are different for each. As an example, let’s compare the taxation rates between direct income (earned) and capital gains (unearned) for individual single taxpayers in 2021. For earned income, the following taxes apply:
- 12% for incomes over $9,950
- 22% for incomes over $40,525
- 24% for incomes over $86,375
- 32% for incomes over $164,925
- 35% for incomes over $209,425
- 37% for incomes over $523,600
A capital gain rate of 15% applies if your taxable income is more than $40,400 but less than or equal to $445,850 for single; more than $80,800 but less than or equal to $501,600 for married filing jointly or qualifying widow(er); more than $54,100 but less than or equal to $473,750 for head of household or more than $40,400 but less than or equal to $250,800 for married filing separately.
Tax Credits for Earned Income
There are tax credits available to exclude a portion of your taxable earned income, thus reducing your total tax liability. Some examples include the Earned Income Tax Credit (EITC) and Student Earned Income Exclusion.
The EITC is a tax credit available to taxpayers with low to moderate income; in 2021, your earned income had to be less than $51,464 if you had three or more qualifying children. It can reduce the amount of tax owed to the government and may even issue a refund to qualified taxpayers. The credit amount will vary based on the number of your dependents and your income.
Claiming the Earned Income Tax Credit can delay your tax refund. The IRS can’t issue your refund before Feb. 15.
The Student Earned Income Exclusion is another type of tax credit available to students under age 22. In January 2022, the amount we will exclude is $2,040 monthly up to a yearly maximum of $8,230. To qualify, students had to be regularly attending school (i.e., eight hours a week in a college university or 12 hours a week in grades seven to 12).
Types of Earned Income
Here are some common examples of earned income (although this list is does not cover every type of earned income):
- Wages, salaries, and tips: Monetary compensation paid to you by your employer. Any tips gained while working your job, such as tips a server earns at a restaurant, is also considered earned income.
- Earnings from gig economy work: Gig economy work is often considered one-off jobs or freelancing work where people provide creative or professional services. This can include working for a rideshare company delivering food or ferrying people.
- Self-employment earnings: If you own a business, any sales you generate are considered earned income. The IRS includes earnings obtained as a minister or member of a religious order in the self-employment category.
- Royalties: Regular payments in relation to the publication of a work, such as a book or a song, are classified as earned income.
- Honorarium: Honoraria is considered payments for services or activities unrelated to your designated responsibilities. This may include payment for speaking at an event, writing an article, or participating in a convention, as well as reimbursement for your travel lodging and meals.
- Union strike benefits: Any payments received as benefits from a union strike must be included when reporting your income.
- Long-term disability benefits: If you claim disability retirement benefits before reaching the minimum retirement age and you are claiming the Earned Income Tax Credit, those benefits may qualify as earned income.
- Earned income is any taxable money received as compensation from your employer or sales generated from a business you own.
- Examples of earned income include hourly wages, salaries, tips, and business sales.
- Earned income should not be confused with unearned income such as interest and dividends from investments, pensions, Social Security payments, alimony, and child support.
- Sources of earned income and unearned income are typically taxed at different rates.
- There are various types of tax credits that allow businesses and individuals to exclude certain amounts from their taxable earned income, such as the Earned Income Credit (EIC) and Student Earned Income Exclusion.