Whether income is considered earned or unearned is significant, because earned income qualifies you for many more tax benefits than unearned income. For example, rules regarding contributions to a Roth IRA are tied to your amount of earned income, and taxpayers who don't have any earned income aren't allowed to claim the earned income tax credit (EITC). Before you claim any credits or deductions based upon your pension, determine the category into which your income fits.
The best way to distinguish earned income from unearned income is to think of earned income as active income and unearned income as passive income. Earned income is income you actively do work to earn, whereas unearned income is passive in nature.
Earned income is defined as income you get from working. The work you do can be for yourself as a small business owner or for someone else as an employee. The key point is that earned income usually comes in the form of wages, salaries, tips and self-employment income. However, earned income can include strike benefits and long-term disability taken before full retirement age. Note that even though neither of these forms of earned income is derived directly from working, each has an indirect association with work, as they are substitute payments for wages.
Unearned income usually derives from passive income, such as unemployment compensation, child support, pensions, Social Security benefits, alimony or interest or dividend income. Because pension income is not considered earned income, it does not qualify you for any IRS credits that list earned income as a prerequisite.
In addition to determining your eligibility for deductions and credits, your amount of unearned versus earned income affects whether you are required to file an income tax return if you are a dependent. For example, single dependents who are not blind or at least 65 years old are required to file tax returns if their unearned income is at least $950 or their earned income is at least $5,700. Single dependents also are required to file tax returns if their gross income is more than the larger of $950 or their earned income (up to $5,400) plus $300. Married dependents are required to file a tax return if their unearned income is over $2,050 or their earned income is over $6,800. Married dependents also are required to file tax returns if their gross income is more than the larger of $2,050 or their earned income (up to $5,400) plus $1,400.