Earned income, investment income, and portfolio income are three primary sources of income that individuals can derive from various sources. Each type of income has its own unique characteristics and tax treatment, so it’s important for individuals to understand how they differ from one another. In this article, we’ll take a closer look at earned income and how it differs from investment and portfolio income.
Earned income is the most common form of income for most individuals. It includes wages, salaries, bonuses, tips, and other forms of compensation that are derived from working for an employer or running a business. The key feature of earned income is that it is directly tied to the individual’s personal labor or effort. This type of income is subject to payroll taxes, such as Social Security and Medicare taxes, in addition to federal and state income taxes. Earned income is typically reported on a W-2 form for employees and on a Schedule C for self-employed individuals.
On the other hand, investment income is derived from various investment vehicles, such as stocks, bonds, mutual funds, real estate, and other forms of assets. Investment income can take the form of interest, dividends, capital gains, and rental income. Unlike earned income, investment income is not directly tied to the individual’s personal labor or effort. Instead, it is derived from the appreciation and income generated by the underlying investment assets. Investment income is subject to different tax treatment, depending on the specific type of income and the holding period of the investment.
Lastly, portfolio income refers to income generated from a portfolio of investments, such as stocks, bonds, and mutual funds. This type of income may include interest, dividends, capital gains, and other forms of investment income. Portfolio income is similar to investment income in that it is derived from the appreciation and income generated by investment assets. However, portfolio income is often associated with a diversified portfolio of investments, rather than a single investment asset. Like investment income, portfolio income is subject to specific tax treatment based on the type of income and the holding period of the investments.
In summary, earned income is derived from personal labor or effort, such as wages and salaries, and is subject to payroll taxes and income taxes. Investment income is derived from various investment vehicles and is subject to different tax treatment based on the specific type of income and the holding period of the investment. Portfolio income, on the other hand, refers to income generated from a diversified portfolio of investments and is also subject to specific tax treatment.
Understanding the differences between earned income, investment income, and portfolio income is important for individuals to effectively manage their tax liabilities and maximize their overall financial well-being. By being knowledgeable about the distinct characteristics and tax treatment of each type of income, individuals can make informed decisions about their financial strategies and ensure that they are optimizing their income potential.