The Internal Revenue Service defines unearned income as investment-type income that doesn't qualify as earned income. In contrast, gifts aren't considered to be income at all by the IRS. Recipients never owe taxes on gifts, but they do owe taxes on unearned income. The tax they pay on unearned income depends on the type of unearned income it is.
If you receive income as a gift, any tax payments are the responsibility of the gift giver. However, you will be responsible for paying tax on unearned income, such as capital gains or bank account interest.
Exploring Gift Income
The IRS considers a gift to be a direct or indirect transfer in which the giver doesn't expect an equal amount of consideration in return. In other words, if someone gives you money or another asset and isn't asking for goods or services in exchange, it's a gift. A gift isn't considered income to the recipient, and the purpose of the money isn't relevant in determining whether or not a payment is a gift. Common examples of gifts are someone paying for your medical bills, covering your tuition, buying you a car or writing a check to help you with living expenses.
Tax Consequences of Gifts
It's the giver, not the recipient, who is responsible for any taxes on gifts. However, most individuals won't have to pay a gift tax on what they give. That's because the IRS gives individuals lifetime exclusion to give tax-free on top of an annual exclusion per recipient. In 2017, the annual exclusion was $14,000 and the lifetime exclusion was $5.49 million. As of 2018, it is $15,000 per recipient per year and an $11,180,000 lifetime exclusion. Some gifts, like paying medical expenses and tuition, are always tax-free. If an individual does determine that he owes tax on the gift, he should fill out Form 709, the Gift Tax Return.
Exploring Unearned Income
The IRS broadly defines unearned income as " investment-type income" or "income other than earned income." Earned income is items like wages, salaries, proceeds from business operations and independent contractor income. The most common types of unearned income are interest, dividends, royalties and capital gains. If you receive any of this type of investment income from a trust, it is also considered unearned income.
Tax Consequences of Unearned Income
Not all types of unearned income are taxed the same. Interest income and short-term capital gains are taxed at your normal tax rate. For example, if you're in the 35 percent tax bracket, any additional interest income and short-term capital gains is taxed at that rate. Long-term capital gains and dividends have separate tax rates that are generally lower than normal tax rates. You generally have a long-term capital gain if you owned the asset for more than a year before you sold it. Otherwise, it's a short-term gain, paid at your normal tax bracket level.
- IRS.gov: Publication 929 - Glossary
- IRS: Frequently Asked Questions on Gift Taxes
- IRS: Form 709
- IRS: What's New - Estate and Gift Tax
- 20-Something Finance: Tax Brackets
- The Motley Fool: Your Guide to Capital Gains Taxes in 2018
- Internal Revenue Service. "Unearned Income." Accessed Nov. 22, 2019.
- Social Security Administration. "What is 'unearned income'?" Accessed Nov. 22, 2019.
- Internal Revenue Service. "Publication 590-A (2018), Contributions to Individual Retirement Arrangements (IRAs)." Accessed Nov. 22, 2019.
- Internal Revenue Service. "What is Earned Income?" Accessed Nov. 22, 2019.
- 26 U.S.C. 21 - Federal Insurance Contributions Act. "Section 2102: Deduction of tax from wages." Accessed Nov. 22, 2019.
- Internal Revenue Service. "Publication 550 (2018), Investment Income and Expenses." Accessed Nov. 22, 2019.
Based in San Diego, Calif., Madison Garcia is a writer specializing in business topics. Garcia received her Master of Science in accountancy from San Diego State University.