What is unearned income?
Unearned income is generally defined as any type of earned income or income that is not the result of receiving a salary, wages or tips for services rendered. Within this broad definition, income is also understood as any type of unearned income that is collected in advance before the provision of the contracted services. This includes deposits on construction or renovation work that will be done by professionals. At the time the project is completed and the balance of the fee is paid in full, the deposit or advance will be classified as earned income.
For many people, unearned income takes the form of funds received as interest or dividends from an investment. Interest earned in a bank savings account or interest-bearing current account can be duly classified as this type of income, since the account holder did not earn the funds by providing services to the bank. Likewise, gains from stocks, bonds, commodities or foreign exchange transactions would be considered unearned income.
Renting real estate is also considered a source of unearned income. While the property is owned by the recipient of the rental income, the income generated is considered to be the result of actions other than the recipient receiving the funds through direct personal effort. The term indirect income is sometimes used to describe the type of income generated by renting a property.
It is important to note that this income is still considered taxable income in most countries around the world. This means that, at some point, the recipient of the unearned income will have to account for the income and pay taxes on the funds received. Depending on the country of jurisdiction, the tax rate applied may be higher or lower than the taxes paid on wages, salaries and tips. In other cases, the total amount can be grouped with income earned in the same period and taxed at the same rate.