Unearned Income Your Safe Way to Earn | management
Many people dream of living on passive income, such as investing in rental properties or dividend stocks. If you are lucky, you can inherit a huge fortune.
In a report published by the American investedwallet, writer Prakash says that passive income sources are different from the fixed income sources you get from working full time.
Income from this type of income source is considered unearned income.
What is unearned income? How is it different from earned income?
It is income derived from sources unrelated to work or personal effort. On the other hand, salary, tips, self-employment and some other sources are considered earned income. Monetizing a blog is also considered earned income, although some bloggers may consider it passive income.
The list of sources of unearned income includes investments, dividends, capital gains distributions, pension distributions, Social Security benefits, unemployment benefits, alimony, child support, lottery winnings, gifts, inheritances, veterans’ benefits, real estate income, fringe benefits, and more.
It is necessary to know the difference between earned and unearned income because they are taxed differently in many countries.
Earned income is subject to regular income and employment taxes, such as social security and health care.
Unearned income is not subject to regular income tax, but to capital gains tax. And people don’t pay employment tax on unearned income.
Examples of unearned income
Example A: In the case of someone who earns a salary of $50,000 a year and then receives a bonus of $5,000, interest income from certificates of deposit of $2,000, and qualified dividends of $2,000, the salary and bonus are considered earned income, while the interest and qualified dividends are unearned income. But all sources of income in this example are taxable.
Example B: The retiree receives $37,000 per year in Social Security benefits and $14,000 per year in pension payments, with the maximum benefit at full retirement age being $3,000 per month in 2021. In this case, both sources represent unearned income.
Types of unearned income
The list below represents the most common types of unearned income:
1. Income from investments
Investment income represents income from the sale of real estate or shares. An investor who sells property for profit realizes a capital gain. For the Tax Administration, capital gains are considered unearned income. Investment income includes interest from savings and money market accounts, certificates of deposit, and bond dividends. The tax rates on capital gains and interest income are different.
2. Long-term capital dividends
Mutual funds pay capital dividends to shareholders. That money comes from the sale of stocks, bonds or other assets owned by the mutual fund. Profit is distributed to shareholders as capital gain. If the mutual fund falls under a taxable account, shareholders must pay tax on this unearned income.
Dividend income is generated from money paid to shareholders from dividends paid by companies. An investor can earn passive income and can live off dividends. As for taxes, it depends on whether the dividend is ordinary or qualified. Ordinary dividends are subject to the regular income tax rate, while qualified stock dividends are subject to 0%, 15% or 20% tax.
4. Pension income
Retirement income comes from pensions, annuities, distributions from pension plans and individual retirement accounts. Social security pensions fall into this category.
Traditional IRA financial contributions are paid without any taxes on withholding, and taxes are collected on withdrawal, ie this type of IRA is tax-deferred and the investor receives a tax deduction when contributing.
5. Unemployment benefits
Unemployment benefits are paid to people who have lost their jobs against their will. For example, a worker who lost his job during mass layoffs receives unemployment benefits. This unearned income is designed to partially replace a worker’s lost income to provide for necessities while looking for another job.
6. Gifts and inheritance
Gifts are considered unearned income, but are still subject to gift tax in certain circumstances. From a tax point of view, gifts are a complex topic, so it is advisable to consult an expert. Gift tax depends on the value of the gift, whether it is money, property, stocks or other assets. In contrast, smaller monetary gifts are not subject to gift tax.
Gifts to spouses and direct payment of school fees are exempt from tax. Unearned income is considered an inheritance that a person receives after the death of a close relative.
Generally, there is no income tax on inherited money, property, stocks or other assets. In contrast, income from inherited rental properties or capital gains from investments sold are subject to tax.
7. Income from real estate rental
Income from renting real estate is considered unrealized income, but it is still taxable. Rental property expenses can be deducted from income and include advertising, maintenance, insurance, taxes, utilities, supplies, repairs, etc.