What is unearned income? Unearned income is any money made without providing a service. For example, interest in a savings account, investment gains in stocks or cryptos, lottery winnings, etc.
Unearned income is any money you’ve received without providing a service. While some people think it’s just money earned for doing nothing, it’s not as simple. Let’s look at some of the nuances of unearned income, the most common types, and how it differs from earned income.
You’ll walk away with a better understanding of what it is and what payments like dividends or capital gains distributions mean for your payroll taxes.
We’ve established that for any income to be considered “earned,” you have to provide a service. Things like earning interest on your savings or subletting your condo don’t qualify.
Even if you put in the time and effort to research and bet on a winning stock or wisely invested your ”earned” money in the right rental property, the IRS still considers any profits unearned income.
Let’s look at a few more examples.
Earned income is money you earn through active work or labor, such as wages or salary. Unearned income is money you receive without actively working. This includes things like interest or dividends.
The IRS identifies many types of unearned income, but most fall into these broad categories:
Let’s look at each one closer.
One of the most common answers to the question “What is unearned income?” is “interest.” At the consumer level, this could be an annual rate your bank pays you on your savings account balance or a certificate of deposit. A business may have more ways to earn interest. For example, one company could earn interest on the funds held on behalf of another company for operating costs such as payroll.
To maximize the interest they earn, Company X also waits until the very last minute to release payroll funds. The interest they earn qualifies as unearned income. 
Example: Payroll Company X regularly receives significant deposits from its business customers. Company X pools the deposits into their bank’s high-yield savings account.
One answer to the question “What is unearned income?” deals with an often overlooked aspect of stock market investing: dividends. When you buy even a single share, you become a part-owner of that company, a shareholder. You’re now entitled to a share of the company’s earnings. Dividends are distributions of earnings based on your number of shares. Not all stocks pay dividends, so research before investing.
Because Sean does not contribute to Ford’s earnings personally, the dividends qualify as unearned income.
Example: Sean got a Ford Bronco and loved it so much that he decided to buy shares of Ford Motor Co. stock.
Instead of buying a company’s stock directly, as Sean did in the example above, you could buy shares in a mutual fund for diversification purposes. If the fund sells a portion of its stock holdings at a profit, it’ll pay you your share. Think of it as a type of dividend. The official term is “capital gains distribution,” a profit made from selling an investment—and another answer to the question “What is unearned income?”
A year later, Tya’s REIT reshuffled its portfolio and sold some of the holdings at a profit. Tya received a capital gains distribution, a type of unearned income.
Example: Tya wanted to invest in real estate but didn't have enough money for a down payment. Undeterred, she bought shares in a real estate investment trust (REIT).
Since time immemorial, renting out land and housing has made lots of people very wealthy. And although the name “landlord” sounds outdated these days, if you rent out an entire property you own, or even a small part of it—like a single room—this “unearned revenue” can make a big difference in your monthly budget. Rental profit is not what jumps to mind regarding unearned income—but it is.
Tenants love how quickly Matt responds to maintenance issues, and Matt benefits from monthly installments of unearned income.
Example: Shortly after college, Matt’s family helped him buy a duplex: a small condo building split in half, each side a separate unit. Matt lives in one unit and rents out the other one.
Another old-fashioned way of acquiring wealth is by inheriting it. Around the world, the wealthy have complained about inheritance taxes for decades. Their argument is not unreasonable: “Our money was already taxed once when we made it, so why tax it again when we pass it on?” But because the heirs don’t provide a service to earn the money, inheritance falls squarely in the “What is unearned income?” category.
Wherever money Sandy receives as a result will be taxed as unearned income.
Example: Sandy’s uncle in Boston, who lived alone, recently passed away unexpectedly. The extended family was planning to sell his house and distribute the proceeds as directed in his will.
You can use unearned income streams in many practical ways:
Unearned income gives you the freedom to do things you’ve been putting off and adds to your peace of mind.
Unearned income is still income, and you have to pay taxes on it. Though many unearned income sources qualify for lower tax rates, others enjoy a deferred tax liability—meaning, you don’t pay taxes until later.
Some tax implications of unearned income include:
Between the many types of unearned income and the variability in tax rates, what is unearned income is a deep topic to explore. And it’s worth it because proper reporting on an income statement and accurate tax classifications of various unearned income types can help you stay on the right side of tax laws and save you money, too.
QuickBooks has a handy guide for preparing income statements, as well as best-in-class small business accounting software that can handle all types of income streams—earned and unearned.
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