What Does Earned Income Mean for Tax Purposes?
Not all income is treated the same by the IRS. Learn how the classification of earned income impacts your tax return and financial planning options.
In the United States tax system, earned income refers specifically to compensation received for work or services performed. This distinction separates money you actively work for from money that comes from other sources, such as investments. The Internal Revenue Service (IRS) defines what it considers earned income, a rule that dictates how different streams of money are treated under federal tax law. The amount of earned income a person has can determine eligibility for specific deductions and credits.
What Qualifies as Earned Income
The most common form of earned income is the money received as an employee. These amounts appear on a Form W-2 and represent direct payment for your labor. This includes:
- Wages
- Salaries
- Tips
- Commissions
- Bonuses
For individuals who are self-employed, earned income is the net earnings from their trade or business. This is calculated by taking the gross income from the business and subtracting allowable business expenses and one-half of the self-employment taxes paid.
Beyond typical employment, other specific types of payments also qualify. Union strike benefits paid to members are considered earned income. Long-term disability benefits received from an employer’s plan before you reach the minimum retirement age are also classified as earned income. At the minimum retirement age, these payments are reclassified as pension income and no longer count as earned.
Some less common situations also generate earned income. For instance, fees a minister receives for performing services like marriages are included. Another category involves statutory employees, who receive a Form W-2 with a specific box checked indicating their status; their gross income is treated as earned income. Members of the military can also elect to include their nontaxable combat pay in their earned income calculation, which can be a strategic choice when determining eligibility for certain tax credits.
What Is Not Considered Earned Income
It is also important to understand what does not qualify as earned income. The IRS makes a clear distinction between money earned through labor and income generated passively. This unearned income is still often taxable, but it is treated differently and does not count toward eligibility for certain work-based tax benefits.
Primary examples of unearned income include returns from investments. This category covers interest from bank accounts or bonds, dividends from stocks, and capital gains realized from the sale of assets like real estate or securities. These forms of income are generated by your capital rather than your direct labor and are reported separately on your tax return.
Retirement and other benefits also fall into the category of unearned income. The following payments are not considered earned:
- Pensions and annuities
- Social Security benefits
- Unemployment compensation
- Alimony received under divorce or separation agreements executed after 2018
Child support payments are neither considered earned income nor are they taxable to the recipient.
The Role of Earned Income in Tax Calculations
The distinction between earned and unearned income impacts financial planning, particularly concerning retirement savings and tax credits. To contribute to either a Traditional or a Roth IRA, you must have taxable compensation, which is functionally the same as earned income. Your total contribution for the year cannot exceed your earned income or the annual contribution limit, whichever is smaller. For 2025, the IRA contribution limit is $7,000 for individuals under age 50, and $8,000 for those age 50 and older.
Earned income is also a requirement for some of the largest tax credits available to low- and moderate-income taxpayers. The Earned Income Tax Credit (EITC) is a primary example, designed specifically to benefit working people. To qualify, a taxpayer must have earned income that falls within certain prescribed limits. Without any earned income, a person cannot claim the EITC, regardless of their overall income level.
A similar principle applies to the Child and Dependent Care Credit. This credit helps offset the costs of care for a child or dependent while you work or look for work. To be eligible, you and your spouse (if filing jointly) must have earned income. The amount of work-related expenses you can claim for the credit is limited to your earned income.