Words of the Day—Earned Income vs. Unearned Income – Definitions Matter

In my previous blog post on Brucenomics, I traced the history of the terms “earned income and “unearned income” back to Karl Marx’ infamous book, Das Kapital. Was it coincidence that the U.S. Internal Revenue Service (IRS) chose those two terms to use in its federal tax system back in the early 20th century? I think not!

In this post  I’ll discuss how the U.S. Internal Revenue Service and other government agencies use these terms to ensure that most Americans will find it difficult if not impossible to get out of lower and middle income levels to achieve their “American Dreams”.

The IRS continues to provide the wealthy with with largess and leaves wage earners, retirees, and minorities behind in the dust when it comes to their efforts to build wealth. In my next post I’ll show how the IRS does this. But first let’s look at who is impacted by these IRS lables.

Who Earns What Kinds of Income?

I define Marx’s two categories of income as used by the IRS this way:

  1. Earned Income is what workers get from their labor (“the sweat of their brow”).
  2. Unearned income is what capitalists (a.k.a., investors and inheriters) get from their corporate and real estate incomes.

The IRS framework for federal taxpayers rests upon this hierarchy of these two types of incomes. They split Americans into groups based on types of income we make and the amounts of income we make.

This use of a hierarchical framework of privileged and less privileged individuals instantly creates discrimination against many groups of Americans. Also importantly, it fosters the growing income inequality found within our government—in favor of investors over workers.

Moreover, it isn’t just the IRS that differentiates Americans based on how much money we make and how we make it. Discrimination against minority groups and the poor and middle classes can be found in many of our federal and local government agencies as well.

For example, the title of the so-called “Small Business Administration” is a joke. That agency has evolved to give preferential treament to funding multimillion dollar corporations, like Microsoft, Apple and Chipotle by linking them with hedge fund funders—not to aid to truly small businesses on Main Street.

Bias exists in the EPA too which lets loose toxic chemicals in poorer neighborhoods, and in banks’ redlining for mortgages. Many other agencies throughout our government too. And it’s really obvious when it comes to retirees!

How Definitions of Income Define Individual’s Social Class

Discrimination Against the Poor

“Earned income “and “unearned income” are used by the IRS to “separate the wheat from the chaff.”  Here we’ll start at the bottom, the types of incomes made by the lower social classes.

On the U.S. Government’s Social Security Administration’s website it signals what kinds of income their clients make:

Types of income for SSI purposes:
Earned Income is wages, net earnings from self–employment, certain royalties, honoraria, and sheltered workshop payments.
Unearned Income is all income that is not earned such as Social Security benefits, pensions, State disability payments, unemployment benefits, interest income, dividends and cash from friends and relatives.
• In-Kind Income is food, shelter, or both that you get for free or for less than its fair market value.
Deemed Income is the part of the income of your spouse with whom you live, your parent(s) with whom you live, or your sponsor (if you are an alien), which we use to compute your SSI benefit amount.

Note that all four kinds of income are the kinds of income, and particularly “Unearned Income,” that Social Security lists on its site indicate people who are at the lower end of the wealth status. 

But our federal government’s discriminatory labeling doesn’t end with the classifications of the lower income earners.

Discrimination Against the Middle Classes

Most middle class workers are going to have retirement savings in IRAs, Traditional and Roth, 401k, 403b, etc. plans and/or pensions. When it comes to saving money to “get ahead, these kinds of vehicles are also going to be quite limited at tax time by IRS restrictions.

Here is what Investopedia says about contributing to a Roth IRA retirement plan [bold type not mine]:

Only earned income can be contributed to a Roth IRA. You can contribute to a Roth IRA only if your income is less than a certain amount, called your MGI Modified Gross Income. The maximum contribution limit for 2021 is $6,000; if you’re age 50 or over, it is $7,000.”

NOTE the word “LIMIT” in this sentence above. This means  that you cannot contribute any other kind of income to a Roth IRA, other than working peoples’ earned income.

So what about the unearned income that Investors and Inheriters receive? You know, the richer workers? The salaried workers and middle-class retirees? How does the IRS define their incomes?

Investopedia defines Unearned Income this way:

“Unearned income is income from investments and other sources unrelated to employment.…Unearned income, known as a passive source of income, is income not acquired through work.”

When I ran the above definitions by a friend who had significant inherited wealth, she was outraged. She mmediately protested, “I work!!! You know all the groups i’m in, how I’m actively working on behalf of other people! Who came up with that idea? ”

Investopedia defines Investment Income this way:

Investment income is money that is received in interest payments, dividends, capital gains realized with the sale of stock or other assets, and any other profit made through an investment vehicle. is money that is received in interest payments, dividends, capital gains realized with the sale of stock or other assets, and any other profit made through an investment vehicle. Interest earned on bank accounts, dividends received from stock owned by mutual fund holdings, and the profits on the sale of gold coins are all considered investment income.  Income from long-term investments undergoes different—and often preferential—tax treatment, which varies by country and locality.“ [my italics and bold].

“All of these investment income categories are examples of Unearned Income.”

Notable in Investopedia’s examples are many other kinds of unearned income such as inheritances, rental income based on owning or renting property, capital equipment or owner’s profits from businesses, etc. This marks the zone between the middle classes and the wealthy when it comes to tax time.

Age Discrimination

Here’s the thing I urge retirees to note:

The Social Security Administration’s list refers to Social Security payments and Pensions under” Unearned Income” But Investopedia’s list does not mention these things at the top! It omits pensions, employer plans, annuities, 401K, 403B, government plans, etc.

On Investopedia’s list we don’t see Social Security, Pensions, Employer Retirement Accounts and other upper middle class investments. We only see the types of incomes that Investors and and wealth Inheritors receive and pay taxes on.

Upper middle-class retiree’s income sources, as verified by their higher tax brackets (right now, up to $400,000 yearly), are classified as “unearned income,” just like Social Security and Pensions, for lower income Americans.

For other retirees, disabled workers and miniories, without any unearned income, who rely on Social Security payments alone, this is going to be murder at tax time. (Anyone seen the movie, Nomadland?)

So what’s my point here?

Workers earn lower incomes, and are taxed at significantly higher tax rates on their earnings than investors and inhertiters pay for taxes on their earnings. Investopedia’s articles about income validate this fact.

The category “workers” also includes both self-employed and employed professionals, many of whom are in upper middle class income tax brackets.

Why? Because the IRS limits the amounts that lower- and middle-class workers may use with their “earned” or “unearned incomes” at tax time to obtain IRS deductions or credits from their gross or net incomes.

In my next post, “How The Rich Avoid Taxes,” I’ll show two examples of how the IRS “separates the wheat from the chaff.