The IRS determines your responsibility to file based on your gross income, which consists of both earned and unearned income. This is especially important if you can be claimed as a dependent on someone else’s tax return. Your eligibility for certain tax credits and IRA contributions also depends on how much earned income you have. This article will help you determine the difference between earned and unearned income.
Obviously, any income you earn by working for someone else will be considered earned income. Salaries, wages, tips, professional fees, business income (from self-employment), and farm income all count as earned income. Those are pretty straightforward.
But there are a few tricky ones. For example, alimony counts as earned income. (I’m talking about true alimony – you can’t count child support for this.) Also, income from partnerships, S corporations, trusts, and estates can only count as earned income if they are considered “non-passive”. For the most part, this means you must have actively participated in the business that provided the income. There are special rules relating to rental real estate on this issue. If you’re not sure about your situation, you need to consult a tax professional. Finally, taxable scholarships and fellowship grants can also count as earned income.
That’s pretty much it for earned income. One last note – any earned income that you exclude under the Foreign Earned Income rules does not count as earned income for your IRA contributions. Again, this is another complicated situation that may require talking to a tax professional.
Calculating unearned income is very important if you can be claimed as a dependent on someone else’s tax return. You’ll want to know how much unearned income you have so you can figure out if you’re required to file a tax return. Also, if you’re looking to make IRA contributions, none of these items will count. Here are most of the items that are considered “unearned income” by the IRS:
- Interest & Dividends
- Capital Gains
- Retirement Income (IRA distributions, pensions, and annuities)
- Rental Real Estate Income
- “Passive Income” from partnerships, S corporations, trusts, and estates
- Unemployment Compensation
- Social Security Benefits
- Gambling Winnings
- Cancellation of Debt
- Excluded Income under Foreign Earned Income rules
- and a few others…
Your gross income is the combination of both your earned and unearned income. Knowing what counts for these amounts will help you figure out if you are required to file a tax return and if you’re eligible to make IRA contributions.
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