Rural non-farm employment (RNFE) is thought to curtail increases in rural poverty and income inequality. In the Croatian context three key questions arise: (1) Does the uptake of alternative employment actually help to raise the welfare of small family farms? (2) How is the rural income distribution affected by mixed income structures? (3) Will non-farm diversification rather trigger farm exit or inhibit structural change because a large number of tiny farms persist? In this paper we present results on the effect of RNFE on the income structure and inter-household income distribution among Croatian family farms. The analysis draws on a survey of 175 randomly selected family farms in two Croatian regions in 2007. The poorest farm households have little access to land, and – although dependent on farming incomes they cannot live from agriculture alone. The better-off farms receive significantly higher incomes per hectare of land. RNFE affects rural livelihoods positively in two ways: it is the most important income source of middle income farms, and is found to be an important catalyst that helps smoothing income inequality in the rural context.