Earned income represents the money you actively earn through work or self-employment. This includes wages, salaries, commissions, tips, and net earnings from running a business. Unlike unearned income — such as dividends, interest, or Social Security benefits — earned income requires your direct effort or labor.

Understanding earned income is vital for tax planning because it determines your eligibility for specific tax credits and impacts how much you can contribute to retirement accounts like an Individual Retirement Arrangement (IRA). For example, the Earned Income Tax Credit (EITC) is a refundable tax credit that primarily helps low- to moderate-income workers and families. The amount of earned income you report influences the size of this tax credit.

Examples of Earned Income

  • Employment Wages and Salaries: Your regular paycheck from an employer.
  • Tips: Money received directly from customers while working as a server, bartender, or similar roles.
  • Self-Employment Net Earnings: Profits from freelance work or business activities after subtracting business expenses.
  • Union Strike Benefits: Taxable benefits you may receive during a strike.
  • Certain Disability Benefits: Disability retirement payments received before reaching the minimum retirement age may count as earned income under specific IRS rules.

What Income Does Not Qualify as Earned Income?

Several common income types do not count as earned income:

  • Investment Income: Interest, dividends, and capital gains.
  • Retirement Income: Social Security, pensions, and annuities.
  • Unemployment Benefits: These are taxable but not earned income.
  • Child Support and Alimony: Payments received are not considered earned income.
  • Government Assistance: Welfare benefits and similar aid.

Importance of Earned Income

Tax credits like the EITC depend on your earned income amount. Without earned income, you cannot claim EITC. Additionally, to contribute to a traditional or Roth IRA, you must have earned income at least equal to your contribution amount.

Common Questions about Earned Income

  • Is all my paycheck considered earned income? Yes, your gross wages and tips typically qualify.
  • Does self-employment income count? Yes, but it’s based on your net earnings after expenses.
  • Do unemployment benefits count for the EITC? No, unemployment income is taxable but not earned income.
  • Is rental income earned income? Usually no, unless you materially participate as a real estate professional.

Tips for Managing Earned Income

  • Keep detailed records of all earned income sources.
  • Understand which expenses can be deducted if self-employed.
  • Review IRS guidelines, such as Publication 596, to maximize EITC benefits (IRS Publication 596).

Earned income forms the foundation of many tax benefits and retirement savings options. Recognizing what qualifies as earned income helps taxpayers accurately file returns and optimize credits.