What Is Not Considered Earned Income?
Gain clarity on income that isn't earned. Understand financial inflows not from active work, crucial for tax implications and financial strategy.
Earned income refers to money received for work performed, such as wages, salaries, tips, or net earnings from self-employment. This type of income is generally subject to payroll taxes and can be a determining factor for eligibility for certain tax benefits, like the Earned Income Tax Credit (EITC). Understanding what counts as earned income is important because it directly impacts tax obligations and access to various financial programs. Conversely, income not derived from active work or business participation falls into a different category, influencing how it is treated for tax purposes.
Income from Investments
Income generated from investments does not qualify as earned income. These funds are derived from capital or assets rather than direct labor or active business involvement.
Interest income, for instance, comes from sources like savings accounts, bonds, or certificates of deposit (CDs). This money is considered unearned because it is generated by the money itself, not by a person’s active work or effort. Similarly, dividends received from stock ownership represent a share of company profits distributed to shareholders and are not compensation for services. Capital gains, which are profits from selling assets like stocks, real estate, or other property for more than their purchase price, are also categorized as unearned income. These gains result from market fluctuations and asset appreciation, not from an individual’s active participation in a trade or business.
Rental income, in most scenarios, is generally considered passive or unearned income. This is because it primarily stems from property ownership rather than active personal services. However, if an individual is classified as a real estate professional or is actively and substantially involved in a real estate trade or business, the rental income might be treated as earned income. Royalties, which are payments for the use of intellectual property or natural resources, are also typically unearned income, unless they are directly derived from an active trade or business.
Certain Government and Employer Benefits
Benefits provided by government agencies or former employers are not considered earned income because they are not direct compensation for current work or services. These benefits provide support during unemployment, injury, or retirement.
Unemployment compensation, for example, consists of payments provided for a period of involuntary joblessness. While these benefits are taxable at the federal level, they are not considered earned income because they are not payments for services rendered. Workers’ compensation benefits, paid to individuals for work-related injuries or illnesses, are also not classified as earned income. These payments aim to replace lost wages or cover medical expenses due to an injury.
Social Security benefits, including retirement, disability, or survivor benefits, are unearned income. These payments are based on past contributions to the Social Security system rather than current employment. Welfare benefits, from public assistance programs, are also unearned income, designed to provide support based on financial need, not work performed. Certain disability benefits may or may not be considered earned income, depending on their source and the recipient’s age. Disability payments from an employer’s plan received before minimum retirement age might be earned income, but Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI) are not.
Other Non-Earned Income Sources
Beyond investments and certain government benefits, several other income types are not classified as earned income. These sources do not involve active participation in a trade, business, or employment.
Alimony payments are funds received from a divorce or separation agreement and are not considered earned income. Child support payments, designed for a child’s financial support, are also not considered earned income for the recipient.
Gifts and inheritances represent assets or money received without an exchange of goods or services, and they do not meet the criteria for earned income. Pensions and annuities, which provide retirement income, are another example of unearned income. While the money might have been earned through past employment, the distributions received in retirement are considered unearned. Gambling winnings, whether from lotteries, casinos, or other games of chance, are fully taxable income but are not categorized as earned income for most individuals. Professional gamblers are an exception, as their winnings may be treated as self-employment income.