Unearned Income: Definition, Meaning & Example
It’s critical to comprehend the distinctions between earned and unearned income. This is so that you can effectively optimize your earning potential, as well as submit accurate tax returns so that you don’t have to pay a fine.
So what exactly is unearned income? And what are the types and benefits?
Read on as we take a look at everything to do with unearned income.
Table of Contents
- Unearned income is income that isn’t made through business activities or via work.
- Examples of unearned income include interest, inheritance, or dividends earned from investments.
- Different tax rates are levied on unearned income when compared to earned income.
- Unearned income can serve as supplemental income to your ordinary earned income.
- When you are retired, unearned income is often the only source of income.
What Is Unearned Income?
Unearned income is any income that you receive that was not acquired through work. Examples of unearned income include bond interest, alimony, stock dividends, and interest from savings accounts.
Unearned income is also known as passive income.
Types of Unearned Income
The most typical forms of unearned income are interest and dividend income. When money is obtained in this way, it is termed unearned income and is subject to unearned income taxation.
Other types of unearned income include:
- Retirement accounts such as pensions, annuities, and 401(k)s
- Lottery winnings
- Social Security benefits
- Welfare benefits
- Property income
- Unemployment compensation
- Veterans Affairs benefits
Benefits of Unearned Income
There are many benefits of having access to passive income.
Before retirement, earned income can be supplemented with unearned income; during the post-retirement years, it is frequently the only source of income. For many forms of unearned income, taxes are postponed throughout the accumulation phase.
401(k) plans and annuity income are examples of unearned income sources that permit the deferral of income taxes.
Participants avoid IRS fines and increased tax rates as a result.
Example of Unearned Income
Let’s say that Investor X makes a $5,000 investment. The interest that they get from their investment would be considered unearned income. It therefore must be reported to the Internal Revenue Service (IRS) for taxation at the normal income rate.
Unearned income is any federal income that comes to you passively, meaning you don’t have to work to earn it.
It is a good idea to make investments throughout your working life so that you can enjoy the benefits of having passive income when you are in your retirement years.
FAQS on Unearned Income
The main difference between earned and unearned income is that earned income is income that you work for, while unearned income is made passively.
Yes, unearned income is subject to an unearned income tax.
Unearned money is taxed in several ways. Savings interest is subject to ordinary rate taxation (as if it were earned income). Share dividends are taxed at 7.5 percent for lower rate taxpayers and 32.5 percent for higher rate taxpayers after a $2,000 allowance. Taxes on capital gains income, such as the proceeds from the sale of a home, are levied at a rate of 10% with a higher rate of 20% after a $12,000 deduction.
On IRS Form 1040, lines 2 through 8, you must disclose unearned income. Schedule 1 might need to be attached to your tax return.
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