Unearned Income Definition
Unearned is the income earned from the sources which are not related to employment and includes interest income, dividends, rental income as well as gifts and contributions. In addition, its taxation is different from that of the earned income and tax rates may vary too among the different sources.
Top 4 Examples of Unearned Income
#1 – Interest Income
Interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. is the income which is earned by investors on the investment made by him over the period. Examples of the interest income can be the income earned from the savings deposit accounts, certificates of deposits, loans, etc.
#2 – Dividends
The dividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. is the income earned from the investments that may be taxed at the ordinary rate of taxation or the rate of tax on the long term capital gains. Dividend income is received from the investments in the company, which gives the dividend to its shareholders. Each of the shares in the company gets a percentage of the company’s profit.
#3 – Rental Income
Rental income is the income that a person earns when he rents out his property to another person. The other person pays an amount to the owner of the property for using the owner’s assets. This income derives from means other than the personal effort of the person, and hence treated as unearned income.
#4 – Gifts and Contributions
Gifts and contributions are the amounts received in cash or kind by a person from the other person. In the case of gifts and contribution, people earn income from the sources which are not related to employment, so it is treated as an unearned income.
There are other types as well, which include annuities, prizes, lottery winnings, Proceeds of insurance policies, alimony paymentsAlimony PaymentsAlimony is court-ordered financial support in divorce or separation given to a spouse who has a lower level of income or no income at all. Both husband and wife can ask for alimony. As per law, a divorced spouse has the right to live an equal quality of life as when they were married., Welfare benefits, Inheritances, Retirement accounts, etc. In all such cases, income is earned by the person from the sources which are not related to the employment and do not require personal efforts, so they will be treated as unearned income.
Jill is working in a manufacturing company as the manager of the company. During the month, he earned a salary of $65,000 and a performance bonus of $9,000 from the company. Apart from these, he also earned $5,000 as dividend income and $10,000 as the interest income during the same month. The income earned by Jill from the sources related to the employee will be considered as the earned income, and the income earned from the sources not related to the employee will be regarded as the unearned income.
In the present case, salary and performance bonus is employment-related earning, which involves personal effort. Hence, it will be treated as the earned income. The income from dividend and interest is not related to employment and also does not include personal effort, so it will be considered as the unearned income.
Therefore calculation of earned income using below formula is as follows,
Earned IncomeEarned IncomeEarned income is any amount earned by an individual, such as a salary, wages, or employee compensation. It can also be an individual's income through their own business. = Salary + Performance Bonus
- Earned income = $65,000 + $9,000
- = $74,000
Unearned Income = Dividend Income + Interest Income
- = $5,000 + $10,000
- = $15,000
Jill’s salary and bonus income will be taxed in a different manner than his income from dividend and interest.
- After retirement, it is the only source of income.
- Unearned income from many of the sources helps in deferring the taxes and avoiding the penalties of the IRS.
- It requires little continuous effort to maintain it. Often it requires an initial effort of a considerable amount to create such a source of income. Still, once created after the initial efforts, it gives income over the period of time with little or no amount of additional efforts.
- This income is not typically subject to the payroll tax, employment tax
- In the initial period of creating the source of unearned income, additional efforts and the investments are required, and payment received against such efforts is also not immediate. But once the source of other income is created after the initial efforts, unearned income from many sources give income over the period with the little or no amount of additional efforts
- There may be different tax rates for the income earned from various sources.
The unearned income is the income received from the investments or the other sources which are not related to employment. The different examples include interest received from the investment, dividends, royalties, pension funds. In all the mentioned examples, the income is not derived from the means that require the personal effort of the person, so they are categorized as unearned income.
Such income from many of the sources helps in deferring the taxes and avoiding the penalties of the IRS. There may be different tax rates for the income earned from various sources. It is preferable to diversify the holdings to even out the effect of the applicable taxes.
This article has been a guide to what is Unearned Income and its definition. Here we discuss the types of Unearned Income along with examples, advantages, and limitations. You can learn more about finance from the following articles –