The concept of easy money is embedded in our culture of overnight tech millionaires, lotto winners, and lucky stock picks. Despite this allure, most people make money through a 9-5 job and may only earn passive income by investing time into nurturing it wisely.
While the difference between earned and unearned income may seem trivial, understanding what sets them apart can set you up for financial success.
What Is Employment Income?
Employment income, also known as earned income, is any money you earn from active work. This can include:
There are also a few surprising types of income that are typically classified as earned income. These include:
What Type Of Income Isn’t Earned Income?
Most people earn the lion’s share of their money through earned income. However, it isn’t the only type of income you may receive in a given year. Unearned or passive sources may include:
Developing some of these “hands-off” income streams can be a great way to enhance your financial freedom at every stage of life.
When Does Employment Income Matter?
Knowing the instances when employment income impacts your finances helps you prepare ahead of time, especially when it comes to your taxes.
Earned Income Tax Credit
The EITC is a tax break designed for people with low to moderate incomes. To qualify for the EITC you must claim some form of earned income and have less than $10,300 in investment income.
If you qualify, this “reverse tax” can add $560 to $6,935 to your tax refund each year. This table shows the 2022 Earned Income Tax Credit qualifications.
Earned income is subject to social security taxes and income taxes. While there are strategies to minimize your tax burden, earned income tends to be the most heavily taxed type of income. By contrast, unearned income isn’t subject to Social Security taxation.
Additionally, certain activities (like buying and selling real estate or trading stocks) are taxed using more favorable capital gains tax rates.
Total Disability Monitoring Period
If you have become disabled but still have student loans to pay, you may be eligible for tax-free student loan discharge. But the discharge is only complete after a three-year monitoring period.
During this period, your income may not be higher than the poverty level for a family of two. In the lower 48 states this income threshold is $18,310 in a given tax year. If you earned more than that, you’re not eligible.
Between March 2019 and December 31, 2022, the disability monitoring period is suspended. However, the monitoring period is expected to be reinstated in January 2023. You may not qualify for student loan discharge if you’ve earned too much in the last year, and your loans may be reinstated if this happens during the monitoring period.
Employment income is the income you earn through work while unearned income is money you received from other sources such as alimony or investment dividends.
Both earned and unearned income help secure long-term financial success. However, there are some situations, such as qualifying for student loan discharge due to Total and Permanent Disability (TPD), where minimizing earned income could benefit your situation and sustain the benefits if you are too disabled to work.