what is unearned income 
the term unearned income refers to any income that is not acquired through work put simply unearned income is any money you earn by doing nothing this is in contrast to earned income which is any compensation received for performing a service like work there are many types of unearned or passive income including interest from savings accounts bond interest alimony and dividends from stocks understanding unearned incomeas noted above unearned income is any money that is earned passively it differs from earned income which is any form of compensation gained from employment work or business activities unearned income cannot be contributed to individual retirement accounts iras according to the internal revenue service irs earned income includes wages salaries tips and self employment income 1taxation differs for unearned income and earned income due to qualitative differences the tax rates also vary among unearned income sources most unearned income sources are not subject to payroll taxes and none of them is subject to employment taxes such as social security and medicare 23make sure you understand the origin and taxation of any of your unearned income types of unearned incomeunearned income can fall into a number of different categories we ve listed some of the most common and highlighted some of the key considerations for each below interest and dividend income are the most common types of unearned income money received this way is unearned income and the tax paid on it is considered an unearned income tax interest income is normally taxed as ordinary income on sources that earn income including there are certain exceptions to this rule including interest earned on municipal bonds which is exempt from federal income tax 5dividends which are income from investments can be taxed at ordinary tax rates or preferred long term capital gains tax rates 6 investments typically yield dividends payable to shareholders on a regular basis dividends may be paid to the investment account monthly quarterly annually or semi annually taxation of dividends is based on whether the dividend is ordinary or qualified you may get unearned income from other sources such as benefits of unearned incomeunearned income can serve as a supplement to earned income before retirement and it is often the only source of income in postretirement years during the accumulation phase taxes are deferred for many sources of unearned income sources of unearned income that allow a deferment of income tax include 401 k plans and annuity income as a result participants avoid irs penalties and higher tax rates 910tax advisors often recommend diversifying holdings to even out the effect of taxes on unearned income examples of unearned incomehere are a couple of hypothetical examples to show how unearned income actually works let s say jan invests 50 000 in a cd the interest she derives from her investment is considered unearned income and must be reported to the irs for taxation at the ordinary income rate 4 she also wins 10 000 on a game show but she does not get the full amount of her winnings why because the irs deducts taxes from it treating the amount as unearned income 11now let s suppose that michael buys an investment property with the intention of renting it out for additional income he fixes it up and converts it into two apartments the main unit and the basement as a separate studio he signs leases with two different tenants who pay their rent to michael on the first of each month the tenants rent payments are considered unearned or passive income because michael isn t doing any work to earn them 