What is Earned Income?
Earned income is an IRS term for income that is obtained by completing the given task in terms of a job or by selling products in terms of business. Earned income generally includes salaries, bonuses, wages, commissions, and sometimes tips.
Union strike profits are also considered as earned income, so are long-term disability benefits that are received shortly before minimum retirement age.
Earned income is the total taxable compensation an employee or the worker earns or the total profit a self-employed individual earns, for work. Both employees of any companies and self-employed individuals or businessmen receive earned income and pay taxes on that income.
How Does Earned Income Work?
Let’s assume Danny Cooper works in the marketing department for Company ABC. His salary is $70,000 per year, and this year he also received a $5,000 bonus. His earned income is $70,000 + $5,000 = $75,000.
Let’s assume Danny Cooper quits that job and becomes a waiter at XYZ Restaurant. He makes $9 an hour plus tips. Last year, he earned $25,000 in hourly wages and $10,000 in tips. John’s earned income is $25,000 + $10,000 = $35,000.
What are The Types of Earned Income?
There are two types of earned income:
- Taxable earned income
- Non-taxable combat pay
Taxable earned income mostly includes Wages, salaries, tips, Union strike benefits, and sometimes Long-term disability benefits are also received before minimum retirement age, Net earnings from self-employment.
These types of income are generally earned by employees of any company, people working for the government, or who have their own business. These people, who are bounded with earned income need to pay tax to the governing body to stabilize the growth of their country.
According to IRS, in the non-taxable Combat Pay election, you are allowed to elect your non-taxable combat pay in earned income for the use of the EITC.
The amount of your non-taxable combat pay has to be shown on your Form W-2, in box 12, with code Q. Electing to include non-taxable combat pay in earned income might increase or decrease your EITC.
Understanding The Basics of Earned Income
Both earned income and other types of income are mostly taxable, although sometimes at different percentage rates as assigned by the government.
For the year 2019, the federal government collected taxes from earned income at seven separate rates. Federal income tax rates are proportional. As taxable income grows, it is taxed at even higher rates. Different tax rates are imposed on income in different ranges which depends on the taxpayer’s filing status.
In 2018, the top tax rate applied to the taxable income over $500,000 for single filers that are approximately 37%, and over $600,000 for married couples who file it in joint.
Additional tax schedules and rates apply to taxpayers who file as superior of household and to married individuals filing separate returns. A varied schedule of tax rates applies to capital gains and dividends. Tax brackets are adjusted on an annual basis for inflation.
Why Does Earned Income Matter?
It is earned income that the government generally imposes tax on. Sometimes unearned income is eligible for covering the tax area. The tax collected from these incomes, it’s used for public welfare and the overall development of the country.
The cost of running an entire country is very tensed. It is because of the taxes we pay that the government can perform civil operations. In other words, without taxes, it would be equivalent to impossible for the government to run the country.
Profit taxes are only part of the total business tax cost which is around 39% on average. In the USA, for example, the nominal corporate income tax is based on a progressive scale of 15–30% of net income, but the total business tax bill—even after considering deductions and exemptions—is 73.31% of commercial profit owing to a series of other taxes.
For those people who have a quite low income or mediocre income, there is a credit called Earned Income Tax Credit. The Earned Income Tax Credit (EITC), also called EIC, is a tax credit for employees with low to moderate income.
The earned income tax credit benefits low-income working for families with subsidies. The credit available with the income is a fixed percentage of earnings from the first dollar of earnings until the credit reaches its maximum.
The maximum credit is paid until earnings reach a specified stage, after which it declines with each additional dollar of income until there is no credit available. Eligibility for the tax credit is based on a variety of factors including family size, filing status, and income.
When EITC crosses the limit of the amount of taxes owed, it results in a tax refund for those who claim and qualify for the credit. The credit is often subject to income limitations.