Unearned Income Definition Example Top 4 Types Of Unearned Income

Unearned Income Definition

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. read more is the income that investors earn on their investment over the period. Examples of interest income can be the income earned from the savings deposit accounts, certificates of deposits, loans, etc.

#2 – Dividends

The dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more is the income earned from the investments that may be taxed at the ordinary rate of taxation or the tax rate 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 a person’s income when he rents out his property to another person. The other person pays an amount to the property owner for using the owner’s assets. This income derives from means other than the person’s effort and is 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 contributions, people earn income from sources unrelated to employment, which 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 given to a spouse in case of divorce or separation and is given to the spouse with a lower level of income or no income at all.read more, Welfare benefits, inheritance, Retirement accounts, etc. In all such cases, income is earned by the person from sources unrelated to the employment and does not require personal efforts, so they will be treated as unearned income.

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Calculation

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. Therefore, the income earned by Jill from the sources related to the employee will be considered 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 earnings involving personal effort. Hence, it will be treated as the earned income. The income from dividends and interest is unrelated to employment and does not include personal effort, so it will be considered unearned.

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.read more = 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 differently than his income from dividends and interest.

Advantages

After retirement, it is the only source of income.Unearned income from many sources helps in deferring taxes and avoiding the penalties of the IRS.It requires little continuous effort to maintain. 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 time with little or no additional effort.

Important Points

This income is not typically subject to payroll taxPayroll TaxPayroll taxes are statutory deductions made by the employer from an employee’s regular salary and wages, and usually, such withholdings mostly have both employer and employee equal contributions. These taxes are collected by tax authorities from respective employers and paid for human welfare schemes, infrastructure development.read more, employment tax.In the initial period of creating the source of unearned income, additional efforts and 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 gives income over the period with little or no additional effort.There may be different tax rates for the income earned from various sources.

Conclusion

Unearned income is the income received from investments or other sources unrelated to employment. The different examples include interest received from the investment, dividends, royalties, and 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. However, income earned from various sources may have different tax rates. Therefore, it is preferable to diversify the holdings to even out the effect of the applicable taxes.