Why this matters

Earned income is a core input the IRS uses to decide whether you qualify for the Earned Income Tax Credit (EITC) and how large the credit will be. Small differences in what you count as earned income — wage income versus investment income, for example — can change eligibility or the credit amount materially. For authoritative guidance, see IRS Pub. 596 and the IRS EITC overview (IRS).

What counts as earned income (clear categories)

  • Wages and salaries reported on Form W-2, including taxable fringe benefits and most employee compensation.
  • Tips you report to your employer (taxable tips).
  • Net earnings from self-employment (profit after allowable business expenses reported on Schedule C). You must use the net amount from your tax return.
  • Nontaxable combat pay can be treated as earned income if you elect to include it on your return (IRS option).

What does not count as earned income

  • Unearned income: interest, dividends, capital gains, rental income, and most retirement or Social Security benefits.
  • Child support and most public assistance benefits (SNAP, TANF) are not earned income for EITC.
  • Tax‑exempt interest and tax‑exempt income generally are excluded.

How the IRS uses earned income when calculating EITC

  • Both earned income and adjusted gross income (AGI) affect eligibility: you must be under the yearly income limits for both. The credit amount itself is based largely on earned income (it phases in as earned income rises and then phases out as income exceeds thresholds).
  • The IRS publishes annual tables and worksheets (see Pub. 596) that show how the credit is computed from your earned income and number of qualifying children.

Step-by-step: how to determine your earned income for EITC purposes

  1. Gather records: W-2s, Form 1099‑NEC/1099‑K, Schedule C, and payroll/tip records.
  2. For employees: use taxable wages on your Form W‑2 (box 1) and add any taxable tips you reported.
  3. For the self‑employed: use net profit (or loss) from Schedule C after subtracting ordinary business expenses. If you have a net loss, that can reduce your earned income and may affect eligibility.
  4. Decide whether to include nontaxable combat pay (if applicable) — include it only if it increases your credit.
  5. Compare both your earned income and AGI to the IRS’s current-year limits; check the IRS EITC page for that tax year’s thresholds.

Practical examples (simple)

  • Employee only: A worker with a single W‑2 showing $25,000 in taxable wages has earned income of $25,000 for EITC.
  • Employee + tips: A server with $18,000 wages and $3,000 in reported tips has earned income of $21,000.
  • Self‑employed: A freelancer with $40,000 in gross receipts and $10,000 in allowable business expenses reports net earnings of $30,000 — that net figure is the earned income used for EITC.

Common mistakes and audit triggers

  • Treating investment or other unearned income as earned income (interest, dividends, capital gains).
  • Forgetting to include reported tips or misreporting Schedule C income.
  • Failing to elect whether to include nontaxable combat pay when it would increase your credit.
  • Simple recordkeeping errors (lost 1099s or W‑2s) that lead to mismatched information with IRS records.

Documentation and recordkeeping tips

  • Keep W‑2s, 1099s, business receipts, mileage logs and bank records for at least three years; if you claim the EITC, the IRS may request proof.
  • Use the worksheets in IRS Pub. 596 when preparing your return or ask a tax preparer to run the EITC worksheet.

When to get help

If your income mix is complex (multiple W‑2s, gig work reported on 1099‑NEC or 1099‑K, Schedule C activity, or community property issues), consult a tax professional. In my practice I’ve seen clients lose an eligible credit because they misclassified income or missed the nontaxable combat pay election.

Related resources on FinHelp

Authoritative sources and further reading

Professional disclaimer

This article is educational and not personalized tax advice. Rules and income limits change yearly; check the IRS pages above or consult a qualified tax preparer for advice specific to your situation.