The IRS considers earned income to be any taxable income received from working, including wages, salaries, and tips. This type of income is crucial for determining eligibility for various tax benefits and credits.
Earned income generally includes money you receive from:
- Wages, salaries, tips, and other taxable employee pay. Employee pay is considered earned income only if it is taxable.
- Net earnings from self-employment. This includes income from a business or farm you operate.
- Union strike benefits that are taxable.
- Long-term disability benefits received prior to the minimum retirement age if they are taxable.
- Nontaxable combat pay (for purposes of the Earned Income Tax Credit, if you choose to include it).
Why is Earned Income Important?
Earned income is a key factor in calculating eligibility for significant tax benefits, most notably:
- Earned Income Tax Credit (EITC): This is a refundable tax credit for low-to moderate-income working individuals and families. The amount of the credit depends on your income, filing status, and number of qualifying children.
- Child Tax Credit (CTC) and Additional Child Tax Credit (ACTC): For many families, earned income determines the refundable portion of these credits.
- Retirement Savings Contributions Credit (Saver's Credit): Your adjusted gross income, which is affected by earned income, impacts eligibility for this credit.
- IRA Contributions: You must have earned income to contribute to a traditional or Roth IRA.
What Does Not Count as Earned Income?
It's equally important to understand what the IRS does not consider earned income. These types of income generally do not come from working and therefore do not qualify for the same tax benefits as earned income.
Here's a breakdown of common income types that are not considered earned income:
| Is Earned Income | Is NOT Earned Income |
|---|---|
| Wages, salaries, tips | Child support |
| Taxable employee pay | Unemployment compensation |
| Net earnings from self-employment | Welfare benefits |
| Taxable union strike benefits | Social Security benefits |
| Taxable long-term disability pay | Pensions or annuities |
| Nontaxable combat pay (optional) | Interest and dividends |
| Capital gains | |
| Workers' compensation | |
| Veterans' benefits | |
| Money received from an inheritance or gifts |
Understanding Net Earnings from Self-Employment
For self-employed individuals, earned income is typically your net earnings from self-employment. This is your gross income from your trade or business minus allowable business deductions. You report this on Schedule C (Form 1040), Profit or Loss from Business, or Schedule F (Form 1040), Profit or Loss from Farming.
It's important to keep accurate records of both your income and expenses to correctly determine your net earnings.
Practical Insights
- Keep Good Records: Maintain detailed records of all your income, especially if you are self-employed, to accurately calculate your earned income for tax purposes.
- Consult IRS Resources: For specific scenarios or detailed questions about your earned income, always refer to official IRS publications or use their interactive tax assistant tools on IRS.gov.
- Review Eligibility Annually: Tax laws and credit thresholds can change, so it's wise to review the earned income requirements for any tax credits you plan to claim each tax year.
Understanding what constitutes earned income is fundamental to correctly filing your taxes and maximizing any eligible tax credits.
