What Is Earned Income When It Comes to Filing My Tax Returns?

It sounds like a philosophical question, but really, the IRS just wants the paperwork done right.

What does “earned income” really mean when calculating your earned income tax credit?

When calculating your Earned Income Tax Credit (EITC), it’s essential to understand what is considered earned income.

This type of income plays a significant role in determining the amount of EITC you may be eligible to receive. Earned income includes wages, salaries, tips, and self-employment income earned from providing services or performing a trade or business activity. Investment income, rental income, and other passive sources of income are not considered earned income. .

Types of Earned Income

Earned income refers to the income you receive from working or providing services to others. The IRS recognizes several types of earned income, including wages, salaries, tips, self-employment earnings, royalties, and honorarium.

Wages and salaries are payments individuals receive for their work as an employee, while tips are normally received in addition to a wage. Self-employment earnings, on the other hand, come from individuals who work for themselves or run their own business. Royalties, which are compensation for the use of an individual’s property, are also considered earned income. Lastly, honorariums can be paid as a reward for services rendered, such as speaking engagements or lectures.

Earned income is generally subject to the Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes.

Union Strike Benefits and Compensation Benefits

When it comes to earned income, there are various sources of payments, including payments for union strike benefits and compensation benefits. Although they are both classified as earned income and are subject to taxes, there are some key differences between the two.

Union strike benefits are payments an individual receives during a period of unemployment arising from a labor dispute, where a union is involved. These payments are typically made to substitute for the lost income that would have been earned during the period of unemployment. Although they are considered part of your earned income, union strike benefits are subject to a slightly different tax treatment from regular earned income. They are taxed at the same rate as regular income, but they are not subject to FICA taxes, which include Social Security and Medicare taxes. As such, individuals receiving union strike benefits should keep this difference in mind when calculating their taxable income.

On the other hand, compensation benefits are payments made as a result of an injury, illness, or death incurred while working for an employer. These payments are generally made to compensate you or your family for the loss of income, medical costs, or other expenses related to the workplace incident. Compensation benefits are also considered part of your earned income and are taxable. However, they are taxed differently from union strike benefits. Compensation benefits are subject to FICA taxes, including Social Security and Medicare taxes, just like regular earned income.

Long-term Disability Benefits and Unemployment Benefits

Long-term disability benefits and unemployment benefits are two types of income that must be reported as earned income when filing taxes. Individuals who receive these benefits may also be subject to special reporting requirements and rules.

Long-term disability benefits are payments made to individuals who are unable to work due to a long-term illness or injury. To be eligible for long-term disability benefits, a person must typically have a disability that is expected to last at least one year or result in death. In addition, the person must be unable to perform the duties of their job due to the disability.

Unemployment benefits, on the other hand, are payments made to individuals who have lost their job through no fault of their own. To be eligible for unemployment benefits, a person must have been recently employed (usually within the past year) and have lost their job due to reasons such as a layoff, reduction in workforce, or a business closure.

When it comes to reporting these benefits as earned income, there are specific requirements that must be followed. Long-term disability benefits are reported as earned income on the tax return in the year they are received. The Social Security Administration typically issues a Form SSA-1099 to report these benefits. For unemployment benefits, the state workforce agency typically issues a Form 1099-G to report the amount of benefits received. Unemployment benefits are also subject to federal income tax.

There are also special rules that apply to individuals who receive disability income and those with children with disabilities. For example, individuals who receive Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI) may need to follow different rules for reporting income and may have different tax liabilities. Additionally, individuals with children with disabilities may be eligible for tax credits and deductions to help offset the costs of care.

Reporting Earned Income to the IRS

Reporting earned income to the IRS is an important requirement for all taxpayers in the United States. Whether you are a salaried employee or a freelancer, accurately recording and reporting all sources of income is crucial to avoid any potential legal or financial issues.

To report earned income to the IRS, it is important to start by keeping track of all sources of income. This includes salary and wages, as well as any tips or bonuses received throughout the year. Additionally, anyone who is self-employed or operates as a freelancer must keep an accurate record of all earnings and expenses associated with their business.

Employers are required to provide an annual W-2 form to their employees, which reports their total earnings and amount of taxes withheld from their paycheck. This form is essential for accurately reporting earned income to the IRS. Employees should review their W-2 carefully and ensure that all information is accurate before filing their tax return.

For those who are self-employed, filing taxes can be more complicated. The IRS requires self-employed individuals to report their earnings through quarterly estimated tax payments. As a result, freelancers and self-employed individuals must keep track of all sources of income throughout the year and make payments every quarter to avoid underpayment penalties.

When reporting earned income to the IRS, it is also important to keep track of any deductions or credits that may apply to your situation. For example, business expenses incurred by self-employed individuals can be deducted from their taxable income. Additionally, those who qualify for the Earned Income Tax Credit can receive a refundable credit based on their income level.

Examples of Earned Income

Working a traditional job and receiving a regular paycheck is a common example of earned income. This can include both salaried positions and hourly roles. Professionals who provide services such as consulting, writing, or design work typically earn income through self-employment. Musicians, authors, and other creative professionals can receive income through royalties earned from their work.

People working in the service industry, such as waiters and bartenders, can also earn income in the form of tips. These earnings are typically received in cash and, while not usually reported as taxable income, are still considered a part of earned income.

One form of earned income that may surprise some individuals is long-term disability benefits claimed before reaching the minimum retirement age. While these benefits are typically considered non-taxable income, they are sometimes received in place of a regular paycheck and are therefore considered earned income.

What is Unearned Income?

Unearned income refers to income that is gained from sources other than traditional employment. This can include sources such as interest, dividends, rental income, and capital gains earned from investments. Unlike earned income, which is subject to payroll taxes and other withholdings, unearned income is subject to different tax laws and regulations. In this article, we will explore the concept of unearned income in greater detail and discuss some common examples of this type of income.

Examples of Unearned Income

Unearned income is income that is not considered earned income, which means it is not derived from any employment, service provision, or business operations. Unearned income includes sources of income such as interest, dividends, capital gains, and retirement income. It is important to note that unearned income is not subject to the same rules and regulations as earned income.

In addition to the aforementioned examples of unearned income, there are other types of unearned income that should be considered when calculating taxable income. Social Security benefits, alimony, inheritance, gifts, welfare payments, rental income, annuities, benefits acquired by bartering, and canceled debt are all examples of unearned income.

The general rule of thumb is that any income that does not qualify as earned income is considered unearned income. It is important to include unearned income when calculating taxable income because the Internal Revenue Service (IRS) requires taxpayers to report all sources of income, including unearned income.

Taxpayers must add their unearned income to their earned income amounts to determine their total taxable income. This total taxable income will determine how much an individual or household owes in taxes to the IRS. Furthermore, unearned income can also affect the amount of tax credits and deductions a taxpayer may be eligible for.

What does the IRS not consider income?

Certain items that may be received by individuals are not considered taxable income by the Internal Revenue Service (IRS), although they are still included in gross income. These non-taxable items include child support payments, proceeds from life insurance policies, educational grants and scholarships, gifts, bequests, inheritances, and welfare and workers’ compensation benefits.

Child support isn’t taxable income, neither earned nor passive income. They’re also not tax-deductible to the payer. Similarly, the proceeds from life insurance policies are not taxable income if received due to the death of the policyholder. This includes both term life insurance policies and whole life insurance policies.

Educational grants and scholarships are also not considered taxable income, provided they are used for qualified educational expenses, such as tuition, fees, books, and supplies. However, any portion of the grant or scholarship that is used for non-educational expenses, such as room and board or travel, must be reported as taxable income.

Gifts, bequests, and inheritances are also excluded from taxable income, although the estate or donor may be subject to gift or estate taxes. In some cases, however, if the gift or bequest is part of the recipient’s compensation, such as an employee bonus, it may be subject to income tax.

Lastly, welfare and workers’ compensation benefits are not included in taxable income, although Social Security disability benefits may be taxable depending on an individual’s income. Workers’ compensation benefits are also generally non-taxable, but if an individual receives both workers’ compensation and Social Security benefits, a portion of the Social Security benefit may be taxable.

Compensatory damages awarded in lawsuits for physical injury or illness are also non-taxable income. These damages are intended to compensate the individual for medical expenses, lost wages, and pain and suffering, and are not considered taxable income by the IRS.

How Do I Qualify for the Earned Income Tax Credit (EITC)?

The Earned Income Tax Credit (EITC) is a tax credit designed to provide financial assistance to low and moderate-income individuals or families. To qualify for the EITC, there are certain eligibility requirements that must be met.

One of the primary eligibility requirements for the EITC is earned income. Individuals must have earned income below a certain amount, which varies depending on their filing status and the number of children they claim. 

To claim the EITC, individuals must have a valid Social Security number. They must also be a U.S. citizen or resident alien for the entire tax year and not file a Form 2555 for Foreign Earned Income. The amount of the credit varies depending on the number of qualifying children an individual claims.

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