What is Earned Income?
Earned income refers to income that a person receives from their employment, services, or active participation in businesses, trades, professions, or vocations. It represents the remuneration from labor and services, distinguishing it from income earned from passive investments, such as dividends or interest, which are considered “unearned” income. Understanding earned income is vital for tax purposes as it directly affects the computation of taxable income and tax liabilities. This term is significant in the context of both individual and corporate taxation systems.
Examples of Earned Income
- Salary and Wages: John works as a software engineer and receives a regular monthly salary from his employer.
- Business Profits: Sarah operates a bakery and earns a profit from sales of her baked goods.
- Professional Fees: Dr. Smith, a freelance consultant, receives payment for consulting services.
- Foreign Business Profits: Jane owns a logistics firm that has operations outside her home country, and she earns profits from these foreign ventures.
- Patent Income: Mark, an inventor, receives royalties from a company for using his patented technology.
- Annuity Payments to a Retired Partner: Tom, now retired, receives a portion of annuity payments from his previous partnership in a law firm.
Frequently Asked Questions (FAQ)
1. What constitutes earned income under the current UK taxation system?
Earned income includes income derived from employment, trades, professions, vocations, foreign business profits, patent and copyright income received by creators, and a proportion of annuity paid to retired partners.
2. How is earned income taxed differently from unearned income in the UK?
There is minimal difference in tax treatment between earned and unearned income under the current UK taxation system. However, the nuances can vary based on specific tax credits, deductions, or adjustments that may apply.
3. Is Social Security or pension income considered earned income?
No, Social Security and pension income are considered unearned income because they do not derive directly from current work or active participation in a business.
4. Can income from a rental property be considered as earned income?
Generally, rental income is classified as unearned income unless the rental activity qualifies as a business, wherein active participation is necessary.
5. How do self-employed individuals report earned income?
Self-employed individuals report earned income as business income on their tax returns, often through Schedule C or a similar form, where they can also deduct related business expenses.
6. Do non-residents have to pay tax on their earned income in the UK?
Non-residents may be liable to pay UK tax on the income they earn from work performed in the UK, depending on specific tax treaties and residency rules.
Related Terms
Unearned Income: Income received from sources not requiring active involvement, such as dividends, interest, rental income, and pensions.
Adjusted Gross Income (AGI): An individual’s total gross income minus specific deductions, used to determine taxable income.
Taxable Income: The income amount upon which taxes are calculated after all deductions and exemptions.
Self-Employment Tax: The tax that self-employed individuals must pay, covering Social Security and Medicare taxes, usually computed on net earnings from self-employment.
Gross Income: Total income before any deductions or taxes are applied.
Suggested Online Resources
- HM Revenue & Customs (HMRC) - Types of Income
- Investopedia - Earned Income
- Internal Revenue Service (IRS) - Earned Income and Earned Income Tax Credit
Suggested Books for Further Studies
- “Taxation: Finance Act 2021” by Melville, A.
- “Principles of Taxation for Business and Investment Planning” by Sally Jones and Shelley Rhoades-Catanach
- “The Book on Tax Strategies for the Savvy Real Estate Investor” by Amanda Han and Matthew MacFarland
- “U.S. Master Tax Guide (2021) by Wolters Kluwer Editorial Staff**
Accounting Basics: “Earned Income” Fundamentals Quiz
Thank you for exploring the comprehensive understanding of earned income with our detailed definitions, examples, FAQs, related terms, and quizzes! Keep advancing your financial literacy!
