What Is Earned Income? What Is Unearned Income?

Hi, Snickers Mom! An inheritance will not increase your income taxes, and this year there is no estate tax. (There is no federal inheritance tax.) The main problem you’re going to face is the asset maximums that are in place for Medicaid and other aid programs. You’ll most likely have to spend down those assets before you can receive Medicaid and other aid benefits again. However, I’m not an expert on this so I recommend you try to find someone local who can help you with understanding the requirements for Medicaid and the other aid programs you’re using right now.

Hi, Toni! I appreciate your questions, but unfortunately I don’t have any experience with child support determinations. I can tell you how those items will probably be considered by the IRS though. Assuming the IRA is a traditional IRA and it has no basis (meaning no non-deductible contributions were ever made to it), then the IRS will consider any distribution he takes from that to be taxable income (but not earned income).

The rental property will be handled on Schedule E. Only the net income after expenses will be considered taxable. Whether it’s earned income or not depends on how “actively” he participated in running the rental.

Sorry I can’t be of more help!

Hi, Linwood! It depends on your filing status and number of children (under 17 as of the last day of the tax year). If you let me know that, I can tell you the max.

As long as it’s not income in respect of a decedent the inheritance shouldn’t affect your eligibility for the EIC, Craig. That doesn’t sound like the case in your situation, so I think you should be fine.

Hi, Mistie. I’m assuming you’re asking if you’d be eligible for the Earned Income Credit. Unfortunately, if you don’t have earned income you can’t claim the credit. Child support doesn’t count as earned income. Alimony would count as earned income for IRA contributions but not for the Earned Income Credit. From the sound of it, I don’t think your disability payments would count either.

Hi, Mckenzie! I’m not an expert on disability, food stamps, and Medicaid, but I do not think your friend’s income should affect your ability to get those benefits. You should check with people who work in those areas in your state to double check though.

Hi, Lynn! Thanks for your question. Unfortunately, I believe that interest is taxable and the only place you should report it is on Schedule B as you mentioned. The reason it eliminates your EIC is because it puts you over the investment income limit, which is $3,300. I agree that it stinks, but you’re still coming out ahead. ($5000 – $1700 – $1200 = $2100)

I think you’ll find this document helpful: http://facpa.com/documents/HT_1204C.pdf
It’s a very similar situation to yours and cites the case law supporting the fact that you must report the interest as taxable interest income. If you do not enter it correctly, you will very likely get a letter from the IRS challenging your tax return and requiring you to pay what you owe in addition to possible penalties and interest. I would report the interest on Schedule B if I were you.

Hi, Barbara! I’m not sure I understand your question. Social Security income is considered unearned, but that wouldn’t qualify your mother for anything special.

Hi, Robin! Pension income does not count toward earned income for the EIC even though they withheld federal taxes. Pension income is unearned income but it may still be taxable income, which is why they withheld taxes for you. If you do not need to have taxes withheld (i.e., you own no tax), then you should contact PERS to eliminate the withholding. Thanks for your question!

Well, it sounds like you probably won’t owe any tax, so you’ll get back any federal taxes that were withheld. The child tax credit is $1,000 per child but it only reduces tax you owe. If you don’t owe any taxes, the only way it can help is if you’re eligible for the additional child tax credit (because it’s refundable…the regular child tax credit is not). There’s a separate calculation for the additional child tax credit, but it’s equal to the lesser of the unallowed child tax credit, or 15% of your earned income that is more than $3,000. If you don’t have earned income, you won’t be able to get the credit at all.

To get the EIC you’ll need earned income. So that might be a possibility if that $8,000 you earned was from a job and not just your pension. Hope that helps!

Hi, Wilfredo! Yes, that would be considered unearned income. There are methods of accounting for the taxable portion of a pension based on your contributions and a number of other factors, but they’re too complex to address in a comment. Since you’re a naturalized U.S. citizen, you’ll be taxed just like any other U.S. citizen – so treat your pension according to the same rules. If you’re not able to figure out how to account for everything on your own, I’d recommend hiring a tax professional to help you figure it out.

Hi, Michelle. Your tax preparer should be putting the rental income on Schedule E. But that won’t help you for the EIC. Rental income is considered “investment income” for the EIC limit. So you’ll either need to make sure you write off every legitimate expense to reduce the net income from your property, or you’ll need to sell it so you don’t have this problem next year.

No problem, Michelle. To make sure you use all legitimate expenses, I’d recommend reading over Schedule E and the instructions. Also, your tax preparer should be able to help you with any questions you have (and better than I can since they’ll know your situation better).

As far as property taxes go, you can deduct a portion of them on Schedule E and the rest on Schedule A as an itemized deduction. To allocate the portions, divide the square footage of the rental part of your property by the total square footage of the property. Multiply that by your total real estate taxes and that’s the portion you can deduct on Schedule E. The rest goes on Schedule A. You’ll use the same method for any expense that’s shared between your rental property and the part you use for personal purposes (mortgage interest is another common example).

You’ll really need to work with your tax preparer to make sure you don’t miss anything.

Hi, George. You don’t need to worry. Housing that’s provided for the convenience of your employer (which is true in your case) is considered a nontaxable employee benefit. It is not considered income (earned or unearned).

Hi, Vince. Because your daughter is your dependent and has more than $950 in unearned income she should file a return. However, she won’t owe any federal tax (there may be state tax due…I’m not familiar with CA). You can choose to report her capital gains on your tax return by using Form 8814 so she doesn’t have to file, but then you’ll end up paying a 10% tax on the amount over $950 in gains up to $1,900. (So about $15 in tax…) If your daughter files her own return, there won’t be any federal tax due.

She should qualify for the free file program or you could use TaxAct which is free for everyone (Federal only…state you’d have to pay, just like with the free file program). It’s not a big amount either way, so you may want to use Form 8814 and just pay the extra $15 in taxes.

Hope that helps!

Hi, Loi! The amount of your Social Security that is taxable is figured using the calculation outlined on this page: http://www.irs.gov/publications/p915/ar02.html#en_US_2010_publink100097869

Because of your pension, you’ll probably have to include 85% of your Social Security as taxable income. The pension is not earned income, but the calculation to determine what portion of your Social Security is taxable includes all sources of income. Hope that helps!

Hi, Kyle! I’m not extremely familiar with those types of programs, but I wouldn’t be surprised if your sister would at least qualify for food stamps – even without dependents. My recommendation would be to look up social services/welfare offices near you and get in touch with them. They’ll be your best source of information and help.

Hi, Tom. You won’t need to file returns for the girls unless they have other taxable income and would be required to file. Just Social Security benefits is not enough. To figure out if they provided more than half of their own support, you’ll need to read through this webpage and work through worksheet 3-1 near the bottom: http://www.irs.gov/publications/p17/ch03.html#en_US_2010_publink1000170967

I know the explanation on the IRS site is tedious, but that’s the best answer I can give you because each situation is going to be different. If you did not provide more than half of their support, then you cannot claim them as your dependents.

Hi, Tazzy. Unfortunately, this sounds like a legal issue. I recommend you consult with an attorney on this. I’m afraid I can’t help you. Sorry!

Hi, Jill. I can try to help you, but without having all the pertinent information I can’t guarantee anything. You’ll need to work with a tax pro in your area to be sure of what you should do.

Annuities typically don’t have capital gains. Distributions are either a return of capital or treated as ordinary income. In your case, you need to know what the deceased person’s cost basis in the annuity was on the date of death. Your cost basis will be equal to the proportion you inherited (if you split it 50/50 with someone else, you get half the deceased person’s cost basis). Any distribution you get that is more than this cost basis will be taxed as ordinary income to you (specifically as income in respect of a decedent). Anything up to the cost basis is tax free and will not show up on your tax return as taxable income (assuming you report it correctly by taking the cost basis into account). Your AGI will only be increased by the part that exceeds the cost basis.

The portion that exceeds the cost basis will be considered unearned income and could disqualify you from the EIC. There’s no way around that.

Hope that helps!

Hi, Ellie. Those earnings shouldn’t hurt you for Social Security. Social Security only considers wages that you actually earned while you are receiving your retirement benefit. Deferred compensation and retirement benefits are not generally counted as wages. You can always call the Social Security Administration to check just to make sure though. Hope that helps!

Hi, Baruch! It depends on the type of retirement account you’re talking about. If it’s a traditional IRA, 401(k), 403(b), or similar plan, then yes you will have to pay income taxes on the money when you withdraw it (and you’ll likely have a required minimum withdrawal you’ll be required to take). If it’s a Roth IRA, then you won’t have to pay taxes when you withdraw the money.

Hi, James. You’ve only got part of it right. Only your S-corp distributions would be excluded from the earned income test for Social Security. The problem you’re going to run into though is the IRS requirement that you pay yourself a reasonable salary from your S-Corp before you take any distributions. That salary will get reported on a W-2 and will count toward the earnings limit for Social Security.

Any income you earn while taking Social Security benefits and while you’re under your normal retirement age will reduce your benefits. This is how it works. The first $14,160 (limit for 2010 & 2011) you earn will not lower your benefits at all. Anything you earn over that amount will reduce your benefits. They reduce your benefits by $1 for every $2 you earn over the limit. So in your scenario of earning $62k, they’d ignore the first $14,160 and then reduce your Social Security benefits by $23,920 (half of $47,840). If that’s more than your total Social Security benefit, then you just won’t get any benefits that year.

If you’re going to keep working, I’d recommend delaying your benefits at least until you’ve reached full retirement age and possibly later. There are a lot of variables that go into deciding how late you should delay Social Security, but if you can afford to wait, are healthy, and have a history of long lives in your family then waiting can drastically increase your Social Security benefits.

Hi, Margarita! Assuming you qualify for the exclusion on the gain from the sale of a home, you won’t need to file a federal tax return unless your gain exceeds the exclusion amount. The full exclusion is $250,000 if you’re single and $500,000 if you’re married. That’s an exclusion on the gain not the selling price. To find out if you qualify, check out these IRS resources: http://www.irs.gov/taxtopics/tc701.html & http://www.irs.gov/pub/irs-pdf/p523.pdf

Even if you can’t exclude all of your gain, any excess gain will be treated as unearned income. You won’t get any credits for Social Security on that gain because you don’t pay Social Security tax on it. Hope that clears things up a bit!

I’m sorry, Lois. I don’t know any attorneys in CA. I hope you’re able to get this resolved though!

Rental income is not typically considered earned income for most people. Typically, it will be unearned income. There are some rare circumstances where it is considered earned income, but it typically only applies to real estate professionals or people who have made a business out of renting properties out. So I doubt it would count against you. Also, even if it were considered earned it would be the net income after expenses and not the gross receipts.

There isn’t really a line that shows what your earned income is on your tax return. Some tax software programs will show this for you though. The reason there isn’t a line is because of things like I noted above – sometimes a certain type of income is considered earned and other times it’s considered unearned.

Hi, MCCJr. If the retirement annuity is considered taxable income, then you won’t be able to claim your dad as a dependent. If it’s not, then you may be able to claim him if you meet the other criteria. I don’t know of any way around the gross income test in this case though. Sorry!

Hi, Lois! No need to worry about your IRA distribution going against the earnings limit for Social Security. You will have to pay income taxes on it, but no other taxes will be due on the distribution. The only way the IRA distribution might affect your Social Security is when it comes to calculating how much of your Social Security is subject to income taxes. Other than that, you’ll be fine!

Hi JPS, if you’re a US citizen and you would have needed to file without the Foreign Earned Income Exclusion, then you should have filed all of those years. I would recommend filing the returns you failed to file – you don’t want the IRS coming back on you on these issues.

As far as unemployment benefits go, I do believe they’re only considered unearned and therefore wouldn’t qualify for the Foreign Earned Income Exclusion. Unemployment benefits are taxable. I’m not sure if there’s a different treatment for foreign unemployment benefits, but I doubt it. Sorry I don’t have better news for you!

Hi, Stephen! I see no benefit to you incorporating for your day trading activities unless you want to pay Social Security and Medicare taxes. An S-corp and an LLC (taxed as S-corp) will both flow through to your tax return. This means the character and amounts of your gains will remain the same. The only thing that would change is the fact that you’d have to pay yourself a salary or guaranteed payments. Doing so would require paying payroll taxes or self-employment taxes on income that would otherwise not be subject to such taxes. If you’re looking at doing this solely to lower your taxes, I’m afraid there’s not much benefit here.

The one way you could benefit is by using your salary to fund a retirement plan setup through the S-corp. You could elect to contribute 100% of your salary and effectively lower your income taxes. However, you’ll still have to pay Social Security & Medicare taxes on the amount you defer. You could contribute some without any taxes by making employer contributions though.

To answer your specific questions:

1. Neither will save you more taxes. The main difference between an S-corp and an LLC taxed as an S-corp is complexity of setting up, maintaining, and managing the entity. LLC’s are simpler. But if you elect to have the LLC taxed as an S-corp, there’s not really a difference for tax purposes.

2. Hard to say…none though unless you take advantage of retirement plan options.

3. No. Setting up as an S-corp or LLC in another state just makes things more complicated. There may be some benefits but it’s unlikely in your case. If you did this you’d end up having to register as a foreign corp or LLC in Colorado (if it’s like Pennsylvania). But I’d recommend meeting with an accountant in CO to know for sure.

Best recommendation I can give you overall is to go meet with a CPA or EA (even better, one who specializes in taxes for day traders) before making any major decisions. Hope that helps!

Hi, Donna! While pension income isn’t considered earned income for tax purposes, it may very well be included in the definition of income for the medical help benefit you’re trying to get. That is left up to the aid organization you’re working with. If they say you must include pension income in the income calculation, then I’m afraid there’s no way around it. However, I would strongly encourage you to talk with someone involved with the program as the rules can vary quite a bit. Best to get verification from them. Hope that helps!

Hi, Shawn! Yes, you should be reporting that income on your tax return. It doesn’t matter if you’re issued a 1099 or not. The IRS requires you to report all sources of income. Hope that helps!

Hi, Corey. I believe you’d need to have more than $3,000 of earned income before you could get anything. You would most likely qualify for the Additional Child Tax Credit and the Earned Income Credit if you had some earned income. Otherwise, you won’t be able to get anything from these. Since you are on Social Security with minor children, you may want to check to see that you are receiving all eligible benefits. There are often benefits for minor children of parents on Social Security. Hope that helps!

The taxable income limit for a qualifying relative is $3,700 for 2011. See this page for figuring out whether you can claim your mother as a dependent: http://www.providentplan.com/1421/lower-your-taxes-claim-all-eligible-dependents/ It sounds like you probably can.

In your situation, I would strongly recommend meeting with a CPA, Enrolled Agent, or attorney. Your situation is too complicated to be answered in comments on a blog post. Sorry I can’t be of more help!

Angela, I’m sorry to hear about your situation. I honestly have no idea whether those withdrawals could be considered income for purposes of calculating child support. I would have difficulty seeing it that way since it was awarded as a property allocation, but that’s something you’ll have to leave up to the judge. I’m sorry I can’t be of more help!

Hi, Michelle. I’m not sure what you’re asking. Your disability income could possibly “count” or not count for several things. For income taxes, it’s going to depend on whether you paid for the disability insurance or if it was a benefit paid for by your employer. (If you paid, it doesn’t count as taxable income. If your employer paid, then it does count as taxable income.) However, regardless of how it is counted for income taxes, it may still count for the Earned Income Tax Credit. I’m guessing that’s what you’re asking. As long as you’re under normal retirement age, your disability benefits will count for the EITC. However, Social Security disability does not count as earned income for the EITC. I hope this helps. If you’re unable to figure out how to file your tax return yourself, I’d strongly recommend working with a tax professional near you.