What Are the Four Categories of Income?

Four Categories of Income

In mid-October, the number of Americans applying for unemployment insurance rose to the highest increase since July. About 900,000 Americans applied for unemployment benefits last week. It was over 840,000 the week before. Since these numbers are creeping back up to the 1 million mark it says plenty about the state of the economy. Do you know about the four categories of income? It could help you generate more money in other ways.

Yes, there are four categories of income. There isn’t only one way to earn an income.

If you understand the four categories of income, then the phrase, “working for a living,” could be a relative term for you.

Earned Income (Also Known as Active Income)

The first of the four categories of income you probably know already about is earned income.

Earned income is also the same as active income. An earned income is the money you generate as a livable salary from a job or career.

This is income that you generate from working in an office or telecommuting from home on a contractual basis.

An earned income is an income that must be actively worked for via employment to gain money. As per a contractual basis, once you stop actively working, you stop earning an earned income.

Essentially, you are trading up 40+ hours a week in personal time to make money in a professional employment setting.

An earned income is the salary that is usually generated on a weekly or bi-weekly salary.

The average American salary is only about $48,700 annually or about $940 weekly.

You earn an earned income from a job – as in working as an employee for an individual, business, or corporation. Additionally, you can gain an earned income as a self-employed independent contractor.

Earned income is also one of the four categories of income that is taxed the most heavily. This is especially true if you are self-employed or are an employee.

Within the earned income category, there are several standards of income. For instance, did you know that a, “wage,” and a, “salary are not the same things?

Four Categories of Income (Relative to Earned Income)

There are four subcategories of earned income:

  • Wages
  • Salary
  • Commission
  • Service-based

Wages are the amount of money that an employer pays an employee based on the exact number of hours worked in a workweek.

For example, if you work 37 hours in a week, 8-hours daily, at $15-an-hour, then you made $600. If you are paid wages, you may have to insert a timecard into a time clock when you arrive and leave work. Some online work platforms have even digitized this practice.

If you’re paid wages, then you won’t be paid a penny more or less than the actual hours worked. Construction workers and bus drivers are usually paid wages.

That is not the same as a salary.

A salary pays an income based on a specific job description and assigned duties within a time period. With a salary, you are paid according to the services rendered to your employer within a time period, like a workweek.

If you have a salary, you may get paid the same amount if you come in early, stay late, or leave early.

A commission is a quota-based income where you are paid based on the services you render within a workday. In other words, a commission income is based on the totality of sales you execute, not hourly work.

For example, salespeople, real estate brokers, insurance salespeople, stockbrokers, and so on, gain an income via commission.

An income generated from a service-based business is paid via proprietary services rendered on an individual basis.

For example, a dentist, mechanic, lawyer, home decorator, and so on, are paid a flat-fee to perform a service per client.

Passive Income

A passive income is an income that is generated via mostly passive, low-effort employment, or business means.

Passive income is money generated after the creation or purchase of assets that can be passively leveraged into an income.

This doesn’t mean that absolutely no effort is required to earn a passive income. It just means that relative to the other four categories of income, you don’t have to work as actively to generate income.

With many kinds of passive income businesses, you do most of the work or investment in the beginning. Then, according to your business plan, you recoup investment or generate an income passively.

There are many kinds of passive income businesses that you probably patronize every day and don’t think about.

A laundromat is a passive income business. The owner may have spent hundreds of thousands or even millions investing in washing machines, dryers, supplies, and business space.

Then, all the owner has to do is hire a staff, maintenance crew, and watch as local consumers patronize the laundromat.

People who own vending machines are also passive income business owners.

A vending machine owner could own hundreds or thousands of vending machines in a city or state. Then they, or their employees, would need to service, repair, and collect monies from the vending machines.

Those who own real estate and charge rent to tenants are also passive income business owners.

Other examples of passive income generation include:

  • Affiliate marketing
  • P2P lending
  • Writing and selling e-books

Investment Income

The last of the four categories of income is investment generated income.

The general rule of thumb when it comes to investing that you could expect an annual return of 10%.

However, this is just a generalized rule – there is no set standard when it comes to making a return on investment.

Some financial experts believe you should expect to generate 2% to 7% interest return on investment annually.

Your best chance of generating an appreciable return on investment, a form of income, is to have a diversified investment portfolio.

Examples of income-generating investments include:

  • Bonds
  • Collectibles
  • Currency Exchange
  • ETFs
  • Stocks
  • Mutual Funds
  • Real Estate

Investment income can also be considered a passive income.

Four Categories of Income – One Category of Money

It’s important for you to understand the four categories of income for many reasons.

For one thing, your correct tax bracket depends on your employment status.

Also, if you have many skills, it may be relatively easier for you to make money one way compared to another.

Remember, the more that understand how money actually works, the more you can benefit.

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