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.

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.

Types of Unearned Income

1. Investment Income

Investment income is the profit generated from the sale of real estate or stocks. An investor selling an asset for profit will generate capital gains from the sale. The capital gains are considered as unearned income by the IRS. Investment income includes interest from savings, money market accounts, CDs, and dividends from bonds.

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. The profits are distributed to shareholders as capital gains. If the mutual fund is in a taxable account, the shareholders must pay taxes on this unearned income.

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. For tax purposes, dividend income is taxed differently depending on whether the dividends are ordinary or qualified.

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. Additional types of retirement income include railroad retirement benefits, Department of Veterans Affairs pensions, and payment from Federal funds based on need.

5. Unemployment Benefits

Unemployment benefits are paid to individuals who lose their jobs through no fault of their own. For example, a worker who lost his or her job as part of a companywide layoff would receive unemployment benefits. This unearned income is designed to partially replace a worker’s lost income for necessities as they look for work.

6. Alimony and Child Support Payments

Both alimony and child support payments are considered unearned income. However, alimony payments are taxable in many instances, while child support payments are neither deductible by the payer nor taxable income by the recipient.

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. In other cases, taxes are paid at a particular threshold value or upon sale of the asset.