Earned Income - Work Required

Recently I received an email from a client wanting clarification of his earned income. The school district that he and his wife live in had failed to pass a property tax levy in 12 previous attempts, and now the school district was taking a different approach. The new proposed levy is to tax earned income at 1%. My client and his spouse are retired – does he have earned income?

Obviously at tax time, individuals are in the process of combining different tax forms representing all kinds of household income, but I am asked to clarify the definition of “earned” income many times throughout the year. I would imagine it is the same for many of my fellow professional planners as well. Quite simply – earned income is what you EARN from working – or is attributable to “work-related” activities.

The IRS defines earned income as all the taxable income and wages you get from working. There are two ways to get earned income: You work for someone who pays you OR you work in a business you own or run.

The IRS also defines taxable earned income to include:

• Wages, salaries, tips, and other taxable employee pay;

• Union strike benefits;

• Long-term disability benefits received prior to minimum retirement age;

• Net earnings from self-employment if

  • you own or operate a business, or

  • you are a minister or member of a religious order (Special Rules apply here):

• Gross income received as a statutory employee

Nontaxable Combat Pay election. You can elect to have your nontaxable combat pay included in earned income for EITC – Earned Income Tax Credit – see below.

Examples of Income that is Not Earned Income:

• Pay received for work while an inmate in a penal institution

• Interest and dividends

• Retirement Income

• Social security

• Unemployment benefits

• Alimony

• Child support

Why is it important to know your earned income from other income?
Earned income is used in the calculation to determine if you qualify for other types of credits or income. For example, the Earned Income Tax Credit, sometimes called EITC is a tax credit to help you keep more of what you earned. It is a refundable federal income tax credit for low to moderate income working individuals and families. The IRS website can help you determine if you qualify for the EITC.

What about earned income in retirement? If you are a retiree that has decided to work part-time, your earned income may reduce your social security benefits if you earn too much. If you have attained your full retirement age, you can work and earn as much as you like and receive your full social security benefits – BUT if you are younger than your full retirement age and receiving social security, during tax year 2012 you can only “earn” up to $14,640 and receive your full benefits. Any amount higher will result in reducing your current social security income, although the current reduction will add to your deferred benefits that you receive in the future – you can learn more here at the Social Security Administration.

In the case of my clients, all their income is of the UNEARNED categories. Knowing the difference, particularly at tax time will give you a better understanding of your personal tax situation. As far as the previously mentioned school tax levy, it will be interesting to see if pitting retirees against working families in the district will result in a levy finally being passed.