How to calculate earned income
Calculating your earned income is an essential task, especially when it comes to filing taxes, applying for government benefits, or simply managing your personal finances. But how do you effectively and accurately calculate your earned income? In this article, we’ll take you through the process step by step. We’ll cover what constitutes earned income, how it’s different from unearned income, and specific methods for calculating your earned income.
What is Earned Income?
Earned income refers to the money you earn from working or running a business. It includes wages, salaries, tips, commissions, bonuses, self-employment earnings, and other forms of compensation for services rendered. Earned income is taxable and subject to various deductions depending on factors such as filing status, number of dependents, and employment expenses.
The Difference Between Earned and Unearned Income
While earned income primarily comes from working or running a business, unearned income arises from sources unrelated to active employment. Unearned income includes interest and dividend payments from investments, capital gains on property sales, alimony payments, and pensions among others. Unlike earned income that’s often taxed at higher rates (depending on your tax bracket), unearned income receives preferential tax treatment in many cases.
Steps to Calculate Earned Income
1. Collect all documentation showcasing your work earnings
Start by gathering all necessary documents that show your earned income for the specific period—this could be weekly, monthly or annually. These can include pay stubs, W-2 forms (for employed individuals), 1099 forms (for self-employed individuals), tip records if you receive tips as part of your job.
2. Total up your gross wages/salary
Add up all gross wages (before any deductions) you’ve received during the period in question—use pay stubs or check W-2 forms’ Box 1 for total annual wages. Do the same if you have multiple jobs by adding up each employment’s income.
3. Include other forms of earned income
If applicable, add any income earned through tips, commissions, and bonuses by referring to your tip records or checking for additional payments on your pay stubs. For self-employed individuals, calculate your annual net earnings from your business by subtracting business expenses from your gross income—the resulting amount is your earned income.
4. Adjust for pre-tax deductions
Subtract any mandatory pre-tax deductions such as contributions to retirement plans (401(k), 403(b), etc.) or health insurance premiums. This will provide you with a total adjusted income figure for the period in question.
5. Account for employment and job-related expenses (optional)
Some employment or job-related expenses can be factored in when calculating your earned income, specifically when it comes to tax matters or certain government assistance programs. Consult with a tax professional or refer to specific program guidelines to check if this step is necessary in your situation.
Calculating earned income is a straightforward process that involves tallying up wages, salaries, and other forms of work-related compensation while adjusting for pre-tax deductions and specific expenses related to employment in some cases. Whether for tax filing purposes or gaining a clearer understanding of your personal financial situation, this knowledge will empower you to make informed decisions about your revenue streams and budgeting needs.