All United States citizens and resident aliens must file federal income tax returns if they meet certain conditions. These conditions take into consideration filing status, age, dependency status and gross income. The IRS considers two types of income to make up a taxpayer's gross income: unearned income and earned income. Individuals who meet the conditions set forth by the IRS are required to file a federal income tax return even if they do not owe any federal income taxes.
Earned Vs. Unearned Income
Earned income is money that the taxpayer received as compensation for work performed. The IRS considers any income received that was not earned to be unearned income. Earned income includes salaries, wages, tips, commissions and earnings from self-employment. Union payments for strike benefits and long-term disability benefits received before the taxpayer reaches retirement age are also considered earned income. Dividends, interest, unemployment benefits, retirement benefits and child support payments are examples of unearned income.
Earned income is subject to withholding, meaning the taxpayer's employer withholds a portion of the taxpayer's wages from her paycheck and sends it to the government as prepayment of income taxes, social security taxes, medicare taxes and any state or local income taxes as required by law. Some taxpayers may qualify for exemption from this requirement, while others may request their employer withhold larger amounts from their paychecks, typically to keep from having to pay income taxes at the end of the year. Regardless of how much money is withheld, the employee must report the full amount of her earned income before taxes when she files her federal income tax return.
It is important to distinguish between earned and unearned income due to certain tax benefits and credits that may accrue to the taxpayer. Taxpayers who have earned income and meet certain other requirements may qualify for the Earned Income Tax Credit, which is a refundable credit for low to moderate income families. The credit is figured in part based on the amount of the taxpayer's pretax earned income.
Unearned income is also reported pretax when the taxpayer files his federal income tax return. Unearned income is particularly significant for dependents as it is used to determine whether or not they are required to file a federal income tax return. Individuals who receive nontaxable combat pay have the option of including such pay with their earned income when applying for the Earned Income Tax Credit.