Unearned income, unlike earned income (such as wages or salaries), is not taxed in the same way. Instead of being subject to income tax, unearned income is subject to a different set of taxes. One of the most common types of unearned income is passive income, which is income that is earned without actively working for it. Examples of passive income include dividends from stocks, interest on bonds, and rental income. Passive income is taxed differently than earned income because it is not subject to payroll taxes (such as Social Security and Medicare). However, passive income is still subject to income tax, and the tax rate on passive income is generally higher than the tax rate on earned income.
How Unearned Income is Taxed
When you work a traditional job, you earn wages or a salary that is subject to payroll taxes. But what about when you have income from investments, such as dividends or interest payments? This is known as unearned income, and it is taxed differently from earned income.
Passive Income Taxation
Passive income is a type of unearned income that is generated without active participation. Common examples of passive income include dividends, interest payments, and rental income. Passive income is taxed at a different rate than earned income, and the tax rate depends on your income level.
The tax rates for passive income are as follows:
- 0% for income below $25,000
- 15% for income between $25,000 and $50,000
- 20% for income between $50,000 and $75,000
- 25% for income above $75,000
You can find more information about the taxation of passive income on the IRS website.
Other Types of Unearned Income
In addition to passive income, there are other types of unearned income that are taxed differently from earned income. These include:
- Capital gains: Profits from the sale of capital assets, such as stocks or real estate
- Interest income: Income from savings accounts or bonds
- Dividend income: Income from stocks
- Rental income: Income from rental properties
- Royalties: Income from the use of your intellectual property, such as patents or copyrights
The tax rates for these types of unearned income vary depending on the type of income and your income level. You can find more information about the taxation of unearned income on the IRS website.
Table: Tax Rates for Unearned Income
| Income Level | Passive Income Tax Rate | Other Unearned Income Tax Rates |
|—|—|—|
| Below $25,000 | 0% | 0% |
| $25,000 – $50,000 | 15% | 15% |
| $50,000 – $75,000 | 20% | 20% |
| Above $75,000 | 25% | 25% |
How Earned Income is Taxed
The Internal revenue service (IRS) taxes earned income, which includes wages, tips, and bonuses, at graduated rates. The tax rate you pay depends on your taxable income, or the amount of income left after you subtract certain deductions and credits. The tax rates for earned income are as follows:
- 10% for taxable income up to $10,275 (singles) or $20,550 (married filing jointly)
- 12% for taxable income between $10,275 and $41,775 (singles) or $20,550 and $83,550 (married filing jointly)
- 22% for taxable income between $41,775 and $89,075 (singles) or $83,550 and $170,750 (married filing jointly)
- 24% for taxable income between $89,075 and $170,750 (singles) or $170,750 and $215,950 (married filing jointly)
- 32% for taxable income between $170,750 and $215,950 (singles) or $215,950 and $539,900 (married filing jointly)
- 35% for taxable income between $215,950 and $539,900 (singles) or $539,900 and $1,077,350 (married filing jointly)
- 37% for taxable income over $539,900 (singles) or $1,077,350 (married filing jointly)
The following table shows how the tax rates apply to different income levels:
| Taxable Income | Tax Rate |
|---|---|
| $10,000 | 10% |
| $25,000 | 12% |
| $50,000 | 22% |
| $100,000 | 24% |
| $200,000 | 32% |
| $500,000 | 35% |
| $1,000,000 | 37% |
Distributions from Trusts and Estates
Distributions from trusts and estates are generally taxable to the beneficiary. The type of income distributed, such as dividends, interest, or capital gains, determines the applicable tax rate.
- Simple trusts: Distribute all income earned during the year to the beneficiary. The beneficiary is responsible for paying taxes on the income received.
- Complex trusts: May accumulate income or distribute it to the beneficiary. The trust pays taxes on the accumulated income, and the beneficiary pays taxes on the distributed income.
- Estates: Distribute income to beneficiaries during the administration period. Beneficiaries and the estate may be responsible for paying taxes on the income received.
| Income Type | Tax Rate |
|---|---|
| Ordinary income | Beneficiary’s marginal tax rate |
| Capital gains | 0%, 15%, or 20% (depending on the beneficiary’s tax bracket) |
| Qualified dividends | 0%, 15%, or 20% (depending on the beneficiary’s tax bracket) |
Unearned Income Taxation
Unearned income refers to income generated without active participation in a trade or business. It can include interest, dividends, capital gains, and annuity payments. Unlike earned income, which is subject to both income and payroll taxes, unearned income is only subject to income tax.
Self-Employment Tax Considerations
- For individuals with self-employment income: Unearned income is not subject to self-employment tax, which is a combination of Social Security and Medicare taxes.
- For individuals with both earned and unearned income: The earned income threshold for self-employment tax must be met before self-employment tax applies to any unearned income.
The following table summarizes the taxation of unearned income:
| Income Type | Income Tax | Self-Employment Tax |
|---|---|---|
| Earned Income | Yes | Yes |
| Unearned Income | Yes | No |
Well, folks, that’s a wrap on how unearned income gets hit with the tax hammer. We covered the different types, how the tax rates stack up, and what you can do to minimize the bite. Thanks for sticking with me through all the tax jargon. If you’ve got any more burning money questions, drop back by anytime. I’ll be here, armed with tax knowledge and ready to dish out more financial wisdom. Cheers!