Unearned Income
Income derived from investments and passive sources rather than wages or active work.
What is Unearned Income?
Unearned income is income received from sources other than employment, self-employment, or active business participation. Common forms include dividends, interest, capital gains, rental income, royalties, alimony (for pre-2019 agreements), and pension or annuity payments. The IRS distinguishes unearned income from earned income because they are taxed differently: qualified dividends and long-term capital gains face preferential rates (0%, 15%, 20%), while ordinary unearned income such as interest is taxed at marginal rates. High earners also owe the 3.8% net investment income tax on certain unearned income. Children's unearned income above a threshold may be subject to the kiddie tax.
Example
A retired investor with $800,000 in a brokerage account receives $12,000 in interest, $8,000 in qualified dividends, and realizes $15,000 in long-term capital gains—totaling $35,000 in unearned income for the year. The $12,000 interest is taxed at ordinary rates; the $8,000 dividends and $15,000 gains qualify for the 15% preferential rate, saving roughly $3,600 compared to ordinary income taxation.