Also referred to as “active” income, earned income is money paid to employees by businesses for whom they work. Income received by self-employed individuals is also considered earned income since they are performing a service for another person, a company, or themselves.
Basically, when you perform a task and receive payment for completing that task (regardless of where the money comes from), you are collecting earned income.
Unearned income, also called passive income, is money received by an individual who does not provide a service to receive it.
What are Examples of Earned Income?
The IRS defines earned income as “any taxable income obtained from working a salaried or hourly job and revenue gained from being self-employed.” In other words: W2 wages or 1099 income paid when you perform work.
There are many types of earned income, but here are a few basic examples. If you work for Amazon as a delivery driver and receive a paycheck every week, that counts as earned income. If you own a food truck selling homemade food and receive money from customers, that is also earned income. If you do rideshare as an Uber or Lyft driver and receive payment from them for driving, that is another example of earned income.
What are Examples of Unearned Income?
Income that isn’t W2 or 1099 will likely be classified as unearned.
Some of the most common types of unearned income include:
- Capital gains (investments, cryptocurrency, etc.)
- Dividends
- Fantasy sports winnings
- Betting/gambling winnings
- Inheritance
- Interest
- Lottery winnings
- Rental property
- Retirement (401Ks, pensions, etc.)
- Social Security benefits
- TANF (Temporary Assistance for Needy Families)
- Unemployment
- Veterans (VA) benefits
- Welfare
Does Adjusted Gross Income (AGI) Include Both Earned and Unearned Income?
Yes. For starters, gross income consists of wages, capital gains, dividends, retirement distributions, business revenue, and other types of income.
Adjustments to a taxpayer’s gross income typically involve deductions that help lower that person’s tax liability to minimize the amount of federal and state taxes owed.
After adjusting gross income, the resulting amount is called your adjusted gross income or AGI.
AGI includes both earned and unearned income. Everything you earn during a specific tax year, whether as a worker or from investments and other income sources, must be included in your gross income before adjustments.
Where Do You Enter Unearned Income on Your 1040 Tax Return?
A large section of tax form 1040 is dedicated to income. The IRS provides separate boxes in which you enter amounts of unearned income.
These boxes include:
- Capital gain (or loss)
- IRA distributions
- Pensions and annuities
- Qualified dividends
- Social Security benefits
- Other income from Schedule 1, line 10
How Much Is the Tax on Earned Income?
After calculating for adjustments to your earned income, the resulting AGI amount is what you use to determine your tax bracket and corresponding tax rate.
If you made $80,000 in earned income, subtracted your deductions, and ended up with an AGI of $65,000, you calculate the tax on your adjusted gross income using the most recent tax tables.
The IRS has standard deductions that taxpayers can make on their adjusted gross income. A person’s tax-filing status largely determines the amount of that deduction.
For 2023 tax year, the IRS has established the following deductions for individuals receiving earned income:
- Single filers: $13,850
- Joint filers: $27,700
- Head of household filers: $20,800
How Much Is the Tax on Unearned Income?
Taxes on unearned income are much more complicated than taxes on earned income. Some types of unearned income require filing additional tax forms. Other types of unearned income may allow you to defer taxes.
The IRS expects taxpayers to add the amount of their unearned income to any earned income before determining their adjusted gross income. Failing to include unearned income on your federal tax return can trigger an IRS audit.
Do You Pay Payroll Taxes or Employment Taxes on Unearned Income?
No. You do not have to pay employment or payroll taxes on unearned income. However, the idea that receiving unearned income helps lower your tax liability is a misconception many people make. All unearned income must be added to any earned income at the end of a tax year.
In some cases, unearned income may contribute a significant amount to the tax you owe if you do not take the deductions for which you may be eligible.
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