Calling income "unearned" has nothing to do with how hard you work. It includes gifts and support from friends or family, but it also refers to activities where you work to make money. The IRS defines "earned income" as money you make working for someone else or net profit from a business. Everything else is unearned, no matter how much effort you put in to get it.
Rents and Investments
"Unearned" is a legal classification, not an assessment of your work ethic. No matter how many hours you put in managing your portfolio, for instance, interest and dividends are unearned income in the eyes of the federal government. The same is true if you rent out property: Unless you put in more than 20 hours a week of work as a landlord, rental income is unearned income. If you try to qualify for government aid, rent and investment income counts along with earned income for determining how much help you get.
If you receive alimony or child support, both count as unearned income. The tax treatment is different, though: You pay tax on any alimony you receive, but not on any child support your ex sends you. If your parents provide you with room and board after your divorce or your uncle pays to keep your daughter in day care, those are gifts. Even though they're unearned, you don't have to pay any tax on those dollars. (ref4, 5)
Some kinds of work for an employer do not qualify as earned income. If you go to prison and wind up working for wages, whatever you make isn't "earned" in the government's eyes. When you work for tips, tip income under $20 a month counts as unearned, even though you still pay taxes on it. In-kind payments such as room and board to agricultural workers may not count as earned income.
Benefits you earn during your working career are often classified as unearned income. When you start drawing any retirement benefits -- pensions, annuities, Social Security, veterans' retirement pay, civil-service retirement -- these count as unearned. Unemployment insurance payments are unearned and so is workers' compensation. Any death benefits you receive for a deceased family member, such as life insurance, are unearned too. The income from death benefits is whatever remains after subtracting the costs of burial.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.