Earned Income (Definition, Example) | What is Earned Income Tax Credit?

What is Earned Income?

Earned Income refers to all the income which is earned either from being in active employment (provided it is included in Gross Income) or by running a business. As per US Internal Revenue Services, it includes Wages or Salary, commission, bonus as well as Income earned from Business after adjusting for expenses incurred to earn the same in a gainful profession or business during the taxable year which is usually the Calendar Year in the United States.

An important factor to understand this concept is that it includes all income which one receives for the work done which should involve personal efforts and doesn’t include incomes which are obtained without any effort such as Dividends, Gift etc.

What all Income is Included in the Calculation of Earned Income?

As per IRS guidelines, the following income forms its parts

Long Term Disability benefits received to a person prior to the Minimum age of Retirement
Benefits from Strike received on account of involvement in Union Activities collectively called Union Strike Benefits
Earnings (net of expenses) received from rendering services as a Minister or member of Religious Community
Earnings (net of expenses) in the capacity of a Statutory Employee
Royalties, Commission, and Tips received.

Some of the Income received but not forming part of Earned Income are as follows

Dividend payments received from Stocks and Interest Income from Bonds and Deposits
Income received from retirement
Benefits accrue on account of Unemployment
Social Security Benefits such as Pension or Annuity Payments
Alimony and Child support benefits

Example of Earned Income

Let’s understand the concept with the help of an example:

Riya works as a Risk Manager with Union Global and has earned the following income during the year:

Salary: $20000
Bonus: $8000
Income from providing part-time consultancy: $4000
Dividends from Stocks: $1200

Further, Riya also received the following income:

$5000 alimony from her separation
Interest on Bonds amounting to $3000

In order to calculate the Earned Income of Riya the following Income will be added:

Other Incomes earned/received by Riya are not included in the calculation of Earned Income.

Earned Income Tax Credit (EITC)

Let’s understand the concept in more detail by understanding a concept which is linked to Earned Income Tax Credit(EITC).

Earned Income Tax Credit (EITC) is a type of Tax rebate/credit made available to those whose Income is below a certain threshold as decided by IRS every year. Following points are worth noting in this regard:

Social Security Number (SSN) is a must for an individual to obtain EITC. It is also required for all including spouse and dependent qualifying children while obtaining EITC.
Deductions are provided from Earned Income based on the marital status of the person, number of qualifying children,
Whether Tax return is filed jointly with his/her spouse or not
Exemption relating to Dependent Care Expenses for qualifying children are adjusted from the Income
The concerned taxpayer must have lived in the United States of America for not less than half a year for the year for which such credit is claimed.

Advantages

Increased Earning Income is a sign of economic strength and development of any nation. Higher the number of people having Earning Income more will be the tax collection for the Government which will ultimately lead to expenditure on social welfare schemes and development of the nation.
It figures help in finding the number of people in gainful employment or business which are used by the government for determining various schemes and exemptions

Disadvantages

There are as such no disadvantage of having Earning Income, however, the government needs to ensure the following:

Exemptions should be structured in such a manner that people with a certain level of Earning Income are exempted from tax structure.
Calculation of Earning Income must be simplified so that more and more people having this income are able to compute their tax liability.

Important Points to Note about Earned Income

Two types of Taxes are required to be paid on such income namely Social Security and Medicare Taxes under the Federal Insurance Contribution Act (FICA) and Federal and State Income Tax.
Taxes under FICA comprise of 6.2% as Social Security Tax, 1.45% as Medicare Tax and 0.9% Medicare Surtax (in the case where Income is more than $200000.
A certain category of Taxpayer is eligible for EITC as discussed above based on their Earned Income and number of qualified children, marital status and the exemption keeps changing year on year by IRS.
One should ensure that this income is computed correctly and all eligible incomes forming part of Earned Income are shown to determine correct tax liability and obtain relevant tax rebates.
It is important to have such Income if one wishes to make any contribution to an Individual Retirement Account (IRA).

Earned Income Limits For Tax Year 2019

The maximum amount of credit for Tax Year 2019 is:

$6,557 with three or more qualifying children
$5,828 with two qualifying children
$3,526 with one qualifying child
$529 with no qualifying children

Conclusion

It is the income received in the form of wages and salary and long-term benefits accruing out of disability. One can have this income in two ways either by running a business or by working in gainful employment and receiving pay. There are certain types of Income which don’t form part of Earned Income and are not included for its calculation. Also, there are certain tax credits known as (EITC) which are available as exemptions which further reduces the Taxable Earning Income and consequently the Tax Liability of the Taxpayer.

Earned Income

What is Earned Income?