In layman’s terms, the word “income” refers to the money we earn from working or from operating a business. However, did you know that income can be “earned” or “unearned”? If you’ve never heard of this, don’t worry. In this article, we will explore the difference between earned and unearned income.
|Earned Income||Unearned Income|
|The monetary benefit you receive for the work or services you perform.||The money you receive without actively working or performing a service; often associated with “passive income”|
|Subject to both payroll tax and federal and state income tax||Not subject to payroll tax but is included in the Adjusted Gross Income which is subject to federal income tax|
Earned income is the monetary benefit you receive for work or services you perform or from the business you are operating.
The most common example of earned income is your salary. If you work as a teacher, the salary you receive is counted as your earned income. If you work as a freelance photographer on the side, any payment you receive for your services is part of your earned income.
Other examples of earned income are:
- Professional fees
- Earnings from self-employment
- Sick leave
- Personal time-off pay
- Separation pay
- Union strike benefits
- Long-term disability benefits
- Meal, transportation, and accommodation reimbursement
- Non-cash income such as a car provided by the company
Earned income is taxed. In fact, two types of taxes are subtracted from it: payroll taxes (Social Security/Medicare) and federal and state income taxes.
Unearned income is the money you receive without actively working or performing a service. Some people associate it with “passive income.”
The most common example of unearned income is investment interest. If you have an investment of $10,000 which guarantees 2% interest per month, the amount of $200 is part of your unearned interest every month.
Other sources of unearned income include:
- Corporate Dividends
- Capital gains
- Retirement account distributions
- Social Security benefits
- Real estate earnings
- Gambling winnings
- Debt forgiveness
- Unemployment compensation
- Stocks and bonds
Payroll taxes are not taken from unearned income. However, some unearned income sources are included in your Adjusted Gross Income which is subject to federal income tax.
Earned vs Unearned Income
What, then, is the difference between earned and unearned income?
Earned income is simply the monetary compensation you receive in exchange for labor or services. It is subject to payroll tax and federal and state income tax. On the contrary, unearned income is the money you receive without actively working or performing a service. It is not subject to payroll tax.