The difference between gross income and earned income
Gross income versus earned income: an overview
The distinctions between gross income and earned income are particularly important to understand when it comes to tax accounting. If you report either incorrectly, you could end up paying more taxes than you need to.
Gross income is everything an individual earns in a year, both as a worker and as an investor. Earned income includes only salaries, commissions, bonuses and business income, less expenses, if the person is self-employed.
Key points to remember
- Gross income is all that an individual earns during the year both as a worker and as an investor.
- Earned income only includes salaries, commissions, bonuses and business income, less expenses, if the person is self-employed.
- Gross income and earned income, as well as adjusted gross income and modified adjusted gross income, are essential for the preparation and filing of income tax returns.
According to the Internal Revenue Service (IRS), gross income is defined as all income that an individual receives in the form of money, goods, goods and services that are not exempt from tax. Gross income includes all of the same measures that constitute earned income, namely wages or salaries, commissions and bonuses, as well as business income net of expenses if the person is self-employed.
Gross income also includes investment income in the form of interest and dividends, as well as retirement income from withdrawals from retirement accounts. In addition, gross income includes social security benefits, as well as social security disability benefits, unemployment benefits, alimony, and child support.
According to the IRS, earned income includes wages, salaries, professional fees and other amounts received as compensation for work performed.
Earned income may also include the fair market value of certain employee benefits that are considered taxable by an employer under IRS guidelines, long-term disability benefits received before minimum retirement age, and strike pay resulting from participation in trade union activities.
Earned income does not include the same range of income that is taken into account under gross income.
Make sure you understand the differences between gross income and earned income before preparing and filing a tax return. Other commonly used tax terms that individuals should understand include Adjusted Gross Income (AGI) and Modified Adjusted Gross Income (MAGI). Each of these items is used in a different way to determine your total taxable income and ultimately your total tax liability based on your net income for the year.
Gross income is considered total income for tax preparation and filing purposes. It is used to further determine your total tax payable. This number is also the starting point for calculating your AGI, which is your income after deductions. Your MAGI, on the other hand, is similar to your AGI but with some deductions added to the total.
The IRS uses your total earned income to determine if certain financial actions can be taken throughout the year. For example, you can only contribute to an individual retirement account if you have earned income for the year, and that contribution cannot exceed your total earned income for that year.
Your gross annual income is used to determine the deductions, exemptions, and credits you have available to determine your total taxable income, and then your total tax liability for the year.
Earned income, gross income, adjusted gross income, and modified adjusted gross income form the basis for preparing and filing income tax returns. The difference between labor income and gross income is an important part of your tax accounting.