Question

What is the difference between earned and unearned income?

Answer 1

In simple terms:

- Earned income is money you get from active work or providing services.
- Unearned income is money you get without actively working for it — typically from investments, property, or government payments.

Key points and examples

- Earned income
- Includes: wages, salaries, tips, bonuses, commissions, self‑employment profits, and net earnings from freelance or contract work.
- Tax/treatment: subject to regular income tax and payroll taxes (Social Security and Medicare in the U.S.); it’s the basis for credits like the Earned Income Tax Credit (EITC) and for contributing to IRAs/Roth IRAs (you generally need earned income to contribute).
- Retirement/social benefits: counts for Social Security credits.

- Unearned income
- Includes: interest, dividends, capital gains, rental income (often treated as passive), pensions, annuities, unemployment benefits, most Social Security benefits, and some types of royalties.
- Tax/treatment: generally subject to income tax but not payroll (FICA) tax. Different kinds of unearned income can be taxed at different rates (e.g., long‑term capital gains and qualified dividends often get lower rates than ordinary wages).
- Special rules: some unearned items are tax‑exempt to the recipient (e.g., many gifts and inheritances); others have specific rules (e.g., scholarships, certain Social Security thresholds).

Other practical differences
- Effect on tax credits and deductions: many credits and contribution limits use “earned income” as a qualifier.
- Self‑employment: counted as earned income but also triggers self‑employment tax (the employer/employee payroll tax equivalents).
- Passive vs active: some income (like rental) can be passive or active depending on involvement, which affects how it’s taxed and what losses you can deduct.

If you’d like, tell me your country or a specific income source and I’ll explain how it’s treated there.