Definition of Earned Income
The definition of earned income which comes in line with Internal Revenue Services is that it comprises of the daily wage, salary earned by employees, bonuses paid, commissions given, tips distributed, the net earning which one accumulates from being self-employed and it may also comprise of the disability benefit/union strike benefit or like deferred payment of retirement funds.
Earned income as stated above comprises several categories of income which one may earn either by being an employee working for a firm or by the means of employment. These categories of income are in line with the Internal Revenue Services and can be defined as any income from a job or self-employment. Income that is earned from making investments in other avenues or any sort of government benefit received is not considered as earned income. Taxpayers whose household income is significantly low may be allowed a tax credit on their earned income provided they fulfill the stated conditions to avail the same.
When it comes to the tax purpose the definition of earned income is relatively simpler where it means any kind of income which one has received for the job done by one for the employer or on a self-employment basis. The different criteria of income received which doesn’t classify under earned income are as follows: money accumulated from non-deferred pension plans, alimony, any kind of capital gains on the sale of the property, interest earned from a bank account or any form of investments, dividends earned on investing in stocks, interest on bonds and any type of passive income which has been collected from a source of rental property. It is usually that both earned income and other forms of income are taxable, but the rate of taxation may vary.
Example of Earned Income
The most basic example of earned income can be stated to be the income in the form of salary one gets while working for an employer or the income generated by operating a business where a person is himself or herself self-employed. Nowadays freelancing is a very common job where one works based on his/her skillset and his/her preference without any fixed employer. It is basically finding related projects from all around the globe and usage of one’s skill to provide the desired work to the client on a timely basis. As soon as the project is over, and the output is handed over to the client, the client must provide some kind od pre-decided compensation to the freelancer for getting the job done. This income earned is also stated as earned income and is subject to taxation based on the local tax rules. When an employee earns bonus or in the hospitality industry apart from daily wages employees are subject to tipping also. These tips or bonuses earned by employees are also termed as earned income and subject to taxation.
What Qualifies Earned Income?
The following points described below qualifies what we call earned income:
- Earned income consists of employee salary which are taxable and even the net earnings generated from self-employment.
- Any alimony provided, child support, social security, and unemployment benefits does not qualify as earned income.
- It also consists of any kind of tips or bonus which has been earned by employees.
- It is something which is taxable under Tax laws and doesn’t come for free except in a few cases or scenarios where if the income level is below a certain threshold, the tax credit is provided.
Impact of Earned Income
The impact are as follows:
- It provides the source of living for household and employees can also fetch an extra income in form of bonuses.
- As tipping is also classified under earned income in the hospitality industry it provides an added-on income apart from the usual salary.
- Apart from corporate tax is a major chunk of tax for the federal government where employees working for employers or self-employed individuals has to contribute a certain part of their income in the form of tax to the federal government.
- It helps in uplifting the economy of a nation by proving employment facilities to common people and helping them find a way of living.
- The bridges the gap of the poverty level in a nation and helping people to survive a decent standard of living.
The several advantages are as follows:
- Earned incomes act as a source of living for people who are not in a state to do business and prefer a salaries job.
- It is more of a stable kind of income which is guaranteed every month or day depending on the agreement and unlike business where the risk is also high and at times it may suffer loss.
- The risk reward relationship in earned income is comparatively low when compared to business but the stability of income generated is relatively higher than business.
- It also consist of tipping which act as some form of extra income for certain industries where the basic salary may be low.
- From a tax point of view earned income contributes greatly to the economy in the form of tax payments which help the government utilize the same for public benefits.
The disadvantages are as follows:
- Earned income have a relatively lesser risk reward relation when compared to the income generated from the business.
- It takes away the feeling of entrepreneurship and people tend to become more prone to become salaried employees.
- People can find a couple of loop holes to enjoy the benefit, tax credits and pay less tax to the government.
- One must learn the living in a stipulated limit bound income and never aspire for some other ventures which requires bigger investments.
As stated above we find what are the categories of earned income and what qualifies for the same. Also, we discussed on the pros and cons and how it is crucial for the economy and its people to have a steady source of earned income.
This is a guide to Earned Income. Here we also discuss the definition and impact of earned income along with advantages and disadvantages. You may also have a look at the following articles to learn more –