It’s easy to assume that, when it comes to your taxes, all income is treated the same. However, that’s not correct. The IRS divides your income into two categories: earned income and unearned income.
Earned income is defined as income generated by providing your personal services. This type of income comes from endeavors you are actively involved in, such as your job. Earned income includes self-employment income, W-2 income, tips, and commissions. Earned income is subject to FICA (or self-employment) tax. Additionally, to qualify for the earned income tax credit as well as to be eligible to contribute to IRA accounts or self-employment pension plans, a taxpayer is required to have earned income for the year in question.
Unearned income encompasses money generated through passive activities, rather than personal services. This type of income includes pensions, investments, capital gains, and other passive activities. Unearned income is typically not subject to FICA or self-employment taxes.
When preparing your tax return, it’s important to accurately distinguish between earned and unearned income, due to these differences in how each is taxed. If you have questions about which category applies to a particular part of your income, don’t hesitate to ask. Taxation Solutions, Inc. can help you sort out your earned and unearned income to aid you in avoiding tax problems. Just call now to get started!