These days, people get money in all kinds of ways. However, one of the most common ways is via earned income. And, while you might think that all income is earned income, that’s not actually the case. There’s also such a thing as unearned income, and it’s important to differentiate between the two, especially if you have both, in order to handle your taxes correctly.
What is Earned Income?
As the name implies, earned income is money that comes from working. Or, if you’re disabled, your disability payments also count as earned income. When you have earned income, you’re eligible to contribute to an IRA or a Roth IRA, and you may be eligible for certain other benefits as well. And, of course, earned income is taxed. It is subject to Medicare and Social Security taxes, as well as to income taxes.
What is Unearned Income?
You may never have heard of unearned income, but it’s actually quite common. Any time you have money coming in from something other than working or disability payments, you have unearned income. This money might be alimony payments from a former spouse, annuity payments you receive, or various types of interest income.
It’s important that you are aware of any and all unearned income you receive so that you can report it properly come tax time. That’s right—unearned income has to be reported to the IRS as well. It’s not subject to payroll taxes, which is a relief to many people, but it is taxed as income. However, taxation rates may vary depending on the type of unearned income you have, so it’s wise to work with a tax professional to make sure you don’t accidentally overpay or underpay on any of your earned income.
As you can see, there are two very different types of income, and the IRS wants to know about both of them. Whether you have only one type of income or both, make sure you keep careful records, know and follow the tax rules related to your earnings, and pay the IRS what it’s owed each tax period. Otherwise, you could find yourself facing penalties and interest, which can cut into either type of income significantly
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