Employees and self-employed people have to pay federal income tax on earnings related to work, but the government also imposes income tax on various sources of passive income. Passive income or unearned income describes income that does not require active work, such as interest credited to savings accounts and investment income. The federal income tax rate on unearned income varies from one type of passive income to another.
Financial institutions like banks offer various interest-bearing deposit accounts like savings accounts, money market accounts and certificates of deposit. Interest income credited to an account that is available for withdrawal without penalty is included in your normal taxable income, so the tax rate on interest is your normal income tax rate. Income tax rates range from 10 to 35 percent depending on your annual income.
Cash dividends are periodic payments that corporation and mutual fund companies can make to shareholders. Dividends are divided into two categories for income taxes: ordinary dividends and qualified dividends. Qualified dividends are subject to a maximum tax rate of 15 percent if the normal income tax rate that would apply is 25 percent or higher and 0 percent if the normal rate is less than 25 percent. A dividend is generally considered qualified if it is paid on stock you held more than 60 days during the 121-day period that began 60 days before the ex-dividend date, which is first date new investors are not entitled to receive the stock's next dividend. Ordinary dividends are those that don't meet the criteria to be considered qualified; ordinary dividends are subject to your normal income tax rate.
If you sell an asset like a stock or mutual fund at a price that is higher than the amount you paid, the difference or profit you realize is a capital gain. Capital gains are divided into two categories: short-term gains and long-term gains. Short-term gains are profits realized from the sale of assets you hold a year or less, while long-term gains are profits gained from selling assets you hold longer than a year. Short-term gains are taxed at your normal income tax rate, and long-term gains are taxed at a maximum rate of 15 percent.
Alimony and Child Support
Alimony and child support payments are forms of passive income that are treated differently on tax returns. Alimony received must be included with the rest of your ordinary income for federal income taxes. Child support payments received are not subject to income tax.
Social Security retirement benefits may or may not be taxable depending on your annual income. If your annual income is more than $34,000 as a single taxpayer or $44,000 as a joint filer, up to 85 percent of your Social Security may be included in your ordinary income and taxed at your normal income tax rate. If your income is under $25,000 as a single taxpayer or $32,000 as a joint filer, you don't pay tax on Social Security benefits. If your income is between $25,000 and $34,000 as a single filer or $32,000 and $44,000 as a joint filer, up to 50 percent of your benefits are taxable.
- Internal Revenue Service: Investment Income
- Internal Revenue Service: Topic 403 -- Interest Received
- Internal Revenue Service: Topic 409 -- Capital Gains and Losses
- Internal Revenue Service: What Is Earned Income?
- Internal Revenue Service: Publication 504 -- Main Content
- Nolo: Child Support and Taxes
- U.S. Social Security Administration: Benefits Planner -- Income Taxes and Your Social Security Benefits
- Internal Revenue Service: Tax Information for Non-Custodial Parents
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