Unearned Income: 9 Types You Need to Know About

Many people dream about living off passive income. The concept of working hard and creating a perpetual stream of income is appealing.

Instead of working eight hours per day or more, you can work much less. Suppose you make some smart moves by investing in rental real estate or dividend stocks.

The Internal Revenue Service (IRS) considers these sources of income and several others as unearned income. What is unearned income, and how does it differ from earned income.

What is Unearned Income?

Unearned income is income from sources, not from employment or a job. The IRS views unearned income as income from sources other than personal effort. For example, income from a salary, wages, tips, self-employment, and a few other sources are earned income.

Income from most other sources is unearned income. This list includes investment income, dividend income, capital gains distributions, retirement distributions, social security benefits, unemployment compensation, alimony, child support, lottery winnings, gifts, inheritances, veteran benefits, real estate income, fringe benefits, and others.

Types of Unearned Income

1. Investment Income

Investment income includes interest from savings, money market accounts, CDs, and dividends from bonds. The tax rates on capital gains and interest income may be different.

2. Long-Term Capital Gain Distributions

Mutual funds pay capital gains distributions to shareholders. This money comes from selling stocks, bonds, or other assets owned by the mutual fund.

3. Dividend Income

Dividend income results from money paid to stockholders from the dividends paid by companies. An investor can generate passive income and possibly live off dividends.

4. Retirement Income

Retirement income is derived from pensions, annuities, and distributions from 401(k) plans and Individual Retirement Accounts (IRAs). Social Security retirement benefits are included in this category.

Unearned income is an involved topic. Despite receiving income from a passive activity, the money, stock, property, or asset can still be subject to federal taxes. In some cases, the taxes must be paid in the current year.

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