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Unearned income is any form that does not come from wages, salary, or other earned sources. Unearned income can include investment gains such as interest, dividends, and capital gains; rental income; pensions; Social Security benefits; alimony; lottery winnings; and inheritance.
The amount of unearned income that is taxable depends on the type of unearned income received.
These two income concepts differ one from the other, and here’s why:
Interest, dividends, and capital gains are the most common types of investment income. Investment income is unearned income because the money that is made from investments does not come from work. Instead, it comes from money that has already been earned and put into investments. This means that investment income is not subject to payroll taxes like Social Security and Medicare, but it is still taxable.
This income is the income you earn from renting a property, such as apartments, houses, or land. The money made from the rent comes from the amount you’ve acquired and put into the property.
A pension plan receives income through regular payments or a lump sum distribution.
Pension income is unearned because the money paid out comes from money already earned and saved. Therefore, it’s taxable but not subject to payroll taxes
Benefits are paid to retirees and other eligible Americans by the Social Security Administration (SSA). These benefits are interpreted as this type of income because the money paid out comes from taxes that have been paid into the system by workers.
These are payments made by one spouse to another following a divorce decree or separation agreement. Alimony payments are unearned income because the money that is paid out comes from money that has already been earned and saved.
These represent winnings from state-run lotteries and other gambling activities. These winnings come by change, making it a form of gambling income. Therefore, these are taxable, but they are not subject to payroll taxes like Social Security and Medicare.
Money or property received from a deceased relative or friend. Inheritance is unearned earning because the money or property that is received did not come from work. Instead, it comes from money or property that has already been earned and saved by the deceased person.
Yes. In most cases, the amount of taxable unearned income depends on the type of income received. For example, investment income is generally taxed higher than Social Security benefits. This difference reflects that investment income is considered “more precious” than Social Security benefits.
Unearned income applies different tax rates. For example, the highest tax rate for earned income is 37%, while the top tax rate for this income is just 20%. This difference in rates reflects the fact that unearned income is considered to be less “precious” than earned income by the government.
This means that if you earn money from investments, rental properties, pensions, Social Security benefits, alimony payments, lottery winnings, or inheritance, you will pay less in taxes than if you earn that same money from a job. However, you must still report unearned income on your federal tax return.
There are several ways. The most obvious way is to look at your pay stub and see if any of your income is unrelated to work. If it is, then you have unearned income.
Another way to determine if you have unearned income is to look at your tax return from the previous year. The unearned earning is generally taxable, but there are a few exceptions.
You can also contact the IRS or your tax preparer to determine what types of income are considered unearned. This information can be helpful when filing your tax return or answering questions about this type of income.
Explore our tax planning tools to take the most advantage of your investments. Get started with our calculators. Or access our previous definitions to know more!
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