What is Earned Income?
Earned income refers to the income by the person which can be the amount of salary; wages or employee compensation etc. received from the employer during the employment or can be income by an individual from their own business and such income is included while calculating the income of individual taxable under income tax.
In simple words, it refers to all the income which is earned either from being inactive 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 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 in understanding 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 DividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more, Gift, etc.
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For eg:
Source: Earned Income (wallstreetmojo.com)
What is all Income 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 the 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 IncomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more 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
Examples
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 alimonyAlimonyAlimony is court-ordered financial support in divorce or separation given to a spouse who has a lower level of income or no income at all. Both husband and wife can ask for alimony. As per law, a divorced spouse has the right to live an equal quality of life as when they were married.read more from her separation
- Interest on Bonds amounting to $3000
In order to calculate this Income of Riya, the following Income will be added:
| Particulars | Amount |
|---|---|
| Salary | $20000 |
| Bonus | $8000 |
| Income from providing part time consultancy | $4000 |
| Total Earned Income | $32000 |
Other Incomes received by Riya are not included in the calculation.
Earned Income Tax Credit (EITC)
This Tax Credit (EITC) is a type of Tax rebate/credit made available to those whose income is below a certain threshold as decided by the 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 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 disadvantages 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
- 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 6.2% as Social Security Tax, 1.45% as Medicare Tax, and 0.9% Medicare SurtaxSurtaxSurtax is an additional tax levied on top of the existing income tax in order to support a certain government programme. It can be a percentage of a specified amount or a fixed dollar rate that individuals must pay.read more (in the case where Income is more than $200000.
- A certain category of Taxpayer is eligible for EITC as discussed above and the 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.
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