What is Unearned Income?

The simple definition of unearned income is that which derives from investments rather than direct labor. However, this leaves most of us no wiser than we were as to its applications and fiscal impacts in the real world. Whether you’re interested in pursuing an educational path of accounting and economics or you want to apply these concepts for yourself, understanding how this concept is applied is critical. In the article below, we’ll answer some of the most basic questions about this type of income and explore its implications.

How Can Income Be Unearned?

The name itself seems contradictory to most people, because income typically represents an exchange of value for invested time or energy. This type of income derives from investment of income that has been earned and usually constitutes property that passively recoups dividends. Economists often refer to it as passive income for this reason.

However, there’s a slightly darker edge to unearned income. Land or property earns money in the form of rents, paid by tenants or users of the property to the owner. The 19th century American political economist, Henry George coined the term in question, which is based on a concept older than modernity itself—the idea of rent paid to a landlord. The cultural precedent for this behavior reaches back into feudal Europe, a period during which serfs and freedmen and women paid rents to a local lord for the privilege of working the land for him.

While the term of rent directly derives from the concept to tear or rend money or goods from tenants, defining income that is unearned doesn’t end at this point. In fact, how an economist considers income stems from her or his economic theoretical stance. That perspective incorporates concepts of how ownership is defined, natural or derived rights, and even the value of labor itself.

Through the Theoretical Looking Glass

For the purpose of brevity, we’ll examine the Classical, Neoclassical, and Marxist economic perspectives on passive income. For Classical economists, who place the most emphasis on the dynamism of a competitive market a la Adam Smith, this term refers to any property or income that isn’t subject to the laws of competition. It isn’t a direct product of the individual’s labor, but lies one step removed, and is often represented by land or spatial property that draws rents from tenants.

Neoclassical economists consider these passive incomes as any earnings that exceed the expected returns of investments, labor or property. Windfall earnings are an example of this perspective. If a particular earning threshold is exceeded in the market return or the valuation of property, that income is unearned. Marxist economists take it a step further and classify any income above what is needed to survive as unearned. This perspective influences their assessment of capitalism in both economic and political terms.

In practical terms for the common individual, passive income is classified as any benefit or capital received that isn’t a direct product of a job or business. VA benefits, money received towards the upkeep of shelter, the value of food and shelter received from another, retirement benefits and pensions, lottery prizes or other windfall gifts, inheritances, life insurance policies, strike pay from unions, and even the dividends of IRAs, 401k accounts or other investment types constitute unearned income that must be reported for tax purposes.