Definition
Unearned income refers to income that is not earned from a job or business. It includes things like dividends, interest, or rental income from properties among others. It is considered as passive income because it requires little to no effort to earn and maintain.
Key Takeaways
- Unearned income is a type of income that comes from investments and other sources unrelated to employment. Examples include interest from savings or bonds, dividends from investments, capital gains from selling assets, and income from real estate rentals.
- Unlike earned income such as wages, salaries, and tips, unearned income is often taxed differently, sometimes at lower rates, depending on the country’s tax laws and the type of unearned income.
- The concept of unearned income is significant in tax and welfare benefit laws, as jurisdictions often treat unearned income differently for these purposes. For example, qualifying for some benefits may only take into account earned income, not unearned.
Importance
Unearned Income is a crucial finance term because it provides insights into an individual’s or an entity’s source of income that stems not from active involvement in a business or provision of services but rather from dividends, interest, rents, and other investments.
It is seen as passive income because it is generally received regularly without requiring day-to-day effort.
Importantly, this type of income has different tax implications, often being taxed differently than regular earned income.
Understanding unearned income can help individuals and entities better manage their income streams, potentially optimizing their tax liabilities.
Therefore, unearned income plays a significant role in personal and corporate financial planning, investment strategies, and tax optimization.
Explanation
Unearned income, in the context of accounting and finance, plays a significant role in both businesses and individuals’ financial landscapes. For businesses, the term ‘unearned income’ commonly refers to the income received for goods or services that are yet to be delivered or performed, and therefore it is not yet ‘earned’. It essentially represents a prepayment from customers which provides businesses with a source of working capital upfront before the goods or services are rendered.
As such, this serves as a financial cushion, improving the company’s liquidity position. For individuals, unearned income typically refers to income derived from sources other than employment or business operations, such as dividends, interest, or rent.
It can offer individuals greater financial flexibility and additional income streams, which can be vital for financial planning and investment strategies. Income from these sources can often be used as a way to diversify and increase overall income, supplement retirement funds, and even provide a buffer against income loss from job dismissal or during periods of economic downturn.
This demonstrates the value of unearned income as part of a broader financial strategy.
Examples of Unearned Income
Rental Income: If a property owner leases out a property to a tenant, the money the property owner receives as rent is considered unearned income. In this case, the property owner is not actively working or providing services for this income, instead they are generating it through ownership of an asset.
Dividend Income: When an individual or corporation holds shares in a company, they may receive dividends from that company. This income is considered unearned because it is not a direct result of daily work or a performed service, but rather income that is derived from an investment.
Interest Income: This type of unearned income is received when an individual places money in a savings account or invests in bonds. The interest accrued over time from these investments is considered unearned income because it is monetary gain from initial investment, not from providing services.
FAQs about Unearned Income
What is Unearned Income?
Unearned income refers to income derived from sources other than employment. This includes income from dividends, interest, rent, alimony, or gains from the sale of assets, among others.
Is Unearned Income taxable?
Yes, unearned income is typically subject to federal income tax. However, the tax rate may vary depending on the type and amount of unearned income. It’s recommended to consult with a tax professional for specific advice.
What is the difference between Earned and Unearned Income?
Earned income is money made through work-related efforts such as wages, salaries, commissions, and tips. Unearned income, on the other hand, comes from sources other than employment such as investments, pensions, and dividends.
How does Unearned Income affect Financial Aid?
Unearned income can affect your eligibility for financial aid. When applying for financial aid, both earned and unearned income are considered. High amounts of unearned income could potentially reduce the amount of financial aid you are eligible to receive.
Do children have to pay tax on Unearned Income?
Yes, children may also be required to pay tax on unearned income. The tax is commonly known as the “Kiddie Tax”. This tax applies to children under the age of 19 and certain other circumstances. Again, specific tax advice should be sought from a tax professional.
Related Entrepreneurship Terms
- Passive Income
- Investment Income
- Royalties
- Dividend Income
- Deferred Income
Sources for More Information
- Internal Revenue Service (IRS)– The IRS website offers a great deal of information about unearned income, especially how it is treated for tax purposes.
- Investopedia – This website offers a large encyclopedia of financial terms and concepts, including unearned income.
- Accounting Tools – A comprehensive resource for various accounting and finance topics, including unearned income.
- Forbes – Well-known for its coverage of finance and public affairs, Forbes website could also offer insights into unearned income.
