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Earned Income

Definition

Earned income refers to the money an individual receives as a result of their work or services provided. It usually encompasses wages, salaries, tips, bonuses, and commissions from employment or self-employment. Essentially, earned income is any compensation received in exchange for labor or work-related activities.

Phonetic

The phonetics of the keyword “Earned Income” can be transcribed as: /ˈɜrnt ˈɪnkəm/Breaking it down further:- “Earned” – /ˈɜrnt/- “Income” – /ˈɪnkəm/

Key Takeaways

  1. Earned Income refers to the money a person makes through work, including salaries, wages, tips, and other forms of compensation earned from employment.
  2. Earned Income is subject to taxation, such as federal and state income taxes, as well as Social Security and Medicare taxes.
  3. Earned Income can impact various government benefits, such as the Earned Income Tax Credit (EITC), which is designed to help lower-income workers offset some of their tax burden.

Importance

Earned income is an important term in business and finance as it reflects the actual money earned through active work and performance rather than passive financial sources such as investments or inherited funds. This key metric allows individuals, companies, and governments to assess the strength and productivity of the underlying economy, identify trends in employment and workforce, provide the basis for calculating taxation and social security benefits, and influence fiscal and monetary policies. A significant and stable earned income typically indicates a robust and growing economy, which attracts investors, sustains consumption, supports social, welfare, and retirement systems, and improves the overall quality of life.

Explanation

Earned income is a significant concept in finance and business, primarily because it is the foundation upon which individuals and households build their financial security. In essence, earned income refers to the compensation received by individuals in return for their labor, expertise, or provision of services. Common examples of earned income include salaries, wages, tips, and self-employment income. By identifying and tracking earned income, individuals and families can better plan and manage their financial lives, while organizations and governments can gain insights into the overall economic health of communities, regions, and nations.

The importance of earned income goes beyond simply providing a livelihood for individuals and families. It also serves as a proxy for assessing the strength and vibrancy of labor markets and the economy. Earned income is used to determine eligibility for certain government benefits or tax credits, such as the Earned Income Tax Credit (EITC) in the United States, which aims to support low-to-moderate-income families. Furthermore, this metric helps employers assess the competitiveness of their compensation packages, enabling them to adapt and adjust accordingly in order to attract and retain talent. In a broader perspective, fluctuations in earned income can signal an expanding or contracting economy or shifts in specific sectors, alerting investors, policymakers, and other stakeholders to potential opportunities, challenges, or corrective measures they may need to consider.

Examples

1. Salary or Wages: Earned income includes the money an individual receives from their employer in exchange for their work. For example, if John works at a software company as a software engineer and earns a monthly salary of $5,000, this money is considered his earned income.

2. Self-Employment Income: Earned income can also come from self-employment or freelance work. For instance, Jane is a freelance graphic designer and she works on a project basis for various clients. She charges clients a fixed amount or hourly rate for her design services, and the income she receives from these projects is considered her earned income.

3. Commission-based Income: In some industries, employees earn money based on their performance, commonly referred to as commissions. For example, Sarah is a real estate agent and earns a percentage of the sales price for every property she sells. The money she receives as a result of these property sales is considered her earned income.

Frequently Asked Questions(FAQ)

What is earned income?

Earned income refers to the money earned by an individual through employment, self-employment, or a business. It includes wages, salaries, bonuses, tips, commissions, and net profits from self-employment ventures.

How is earned income different from unearned income?

While earned income is derived from active participation in work, unearned income refers to the passive income generated from investments, rental properties, dividends, interest, and other sources that do not involve active labor.

Is earned income taxable?

Yes, earned income is considered taxable income and is subject to federal income tax, Social Security tax, Medicare tax, and, in some cases, state and local taxes.

What are some examples of earned income?

Examples of earned income include wages, salaries, bonuses, tips, commissions, and self-employment income. It also includes any business profits if you are the sole proprietor, partner, or a member of an LLC (limited liability company).

Does Social Security benefits count as earned income?

No, Social Security benefits are considered unearned income, not earned income. Unemployment benefits and alimony payments are also classified as unearned income.

How does earned income affect tax credits?

Earned income plays a vital role in determining the eligibility for tax credits, such as the Earned Income Tax Credit (EITC) and the Child and Dependent Care Credit. These refundable tax credits are targeted at low to moderate-income earners to reduce the tax burden.

What is the Earned Income Tax Credit (EITC)?

The Earned Income Tax Credit (EITC) is a federal tax incentive designed to assist low to moderate-income workers by reducing their overall tax liability. The EITC is a refundable credit, meaning that if the credit exceeds the taxpayer’s total tax liability, they can receive the remaining amount as a tax refund.

How can I determine if I’m eligible for the Earned Income Tax Credit (EITC)?

Eligibility for the EITC depends on factors like filing status, adjusted gross income (AGI), earned income, and the number of qualifying children. The IRS provides an EITC Assistant Tool on their website to help taxpayers determine their eligibility for the credit.

Are disability payments considered earned income?

Disability payments from an employer’s disability insurance plan can be considered earned income if they represent payments for sick pay or if they were reported on a W-2 as taxable income. However, disability benefits received from Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) are not classified as earned income.

How does earned income affect retirement contributions?

Earned income is an essential factor in determining your eligibility to contribute to retirement accounts such as IRAs and 401(k)s. You must have earned income to contribute to these retirement accounts, and the rules pertaining to maximum allowable contributions often depend on the amount of your earned income.

Related Finance Terms

  • Wages
  • Salaries
  • Tips
  • Commissions
  • Self-employment income

Sources for More Information

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