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You may think of your income as being your paycheck or your freelance earnings, but there are actually many different types of income. If you have stocks that are generating dividends, that’s income, as is interest you earn on any savings accounts. Do you own a rental property that has rent payments flowing your way? That’s income, too.
Here, you’ll learn about seven common types of income and how they may affect your financial life.
Key Points
• Income refers to money earned from labor, investments, or other sources.
• Earned income includes wages, salaries, tips, and bonuses.
• Interest income is earned from interest-bearing financial vehicles: dividend income comes from stock dividends.
• Rental income is earned from property rentals, and capital gains are realized when selling assets for more than their purchase price.
• Royalty income is earned from allowing others to use your property, such as patents or copyrighted work.
What Is Income?
Simply put, income is money that a person or business earns in return for labor, providing a product or service, or returns on investments. Individuals also often receive income from a pension, a government benefit, or a gift. Most income is taxable, but some is exempt from federal or state taxes.
Another way to think about income types is whether it is active (or earned) or passive (or unearned).
• Active or earned income is just what it sounds like: money that you work for, whether you are providing goods or a service.
• Passive or unearned income is money you receive even though you are not actively doing anything to get it. For instance, if you have a high-yield savings account that earns you interest, that is passive income. Government benefits, capital gains, rental income, royalties, and more are also considered passive income. (We’ll go through these variations in more detail in a minute.)
People who are paid a salary may tend to think that their annual paycheck earnings are their income, but in truth, it’s common for people to have multiple income streams. Granted, your salary may be by far the largest stream of income, but when considering your overall financial picture, don’t forget to think about the other ways that money comes to you.
Different Types of Income
Here’s a look at seven common types of income.
1. Earned Income
Earned income is the money you earn for work you do, either in a job or self-employed. Earned income includes wages, salaries, tips, and bonuses.
Earnings are taxed at varying rates by the federal and state governments. Taxes may be withheld by your employer. Self-employed workers often pay quarterly and annual taxes directly to the government. Lower-income workers may be eligible for the earned income tax credit.
2. Business Income
Business income is a term often used in tax reporting; you may sometimes also hear it referred to as profit income. It basically means income received for any products or services your business provides. It is usually considered ordinary income for tax purposes.
Expenses and losses associated with the business can be used to offset business income. Business income can be taxed under different rules, depending on what type of business structure is used, such as sole proprietorship, partnership, corporation, etc.
3. Interest Income
When you put money into various types of interest-bearing financial vehicles, the return is considered interest income. Retirees often rely on interest income to help fund their retirement. You can earn interest from a variety of sources including:
• Certificates of deposit (CDs)
• Government bonds
• Treasury bonds and notes
• Treasury bills (T-bills)
• Corporate bonds
• Interest-bearing checking accounts
• Savings accounts
Interest income is typically taxed as ordinary income, though some types of interest are tax-exempt.
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4. Dividend Income
Some companies pay stockholders dividends as a way of sharing profits. These are usually regular cash payments that investors can take as income or reinvest in the stock. Dividends from stocks held in a taxable brokerage account are considered taxable income. These funds may be taxed at your regular income-tax rate or at a lower long-term capital gains rate, depending on whether they are classified as “ordinary” or “qualified”.
5. Rental Income
Just as it sounds, rental income is income earned from rental payments on property you own. This could be as straightforward as renting a room in your house or as complicated as owning a multi-unit building with several tenants.
Rental income can provide a steady stream of passive vs. active income. It may enhance your livelihood or even be your main income. When your rental property increases in value, you may also gain from that appreciation and increase in equity. In addition, rental income qualifies for several tax advantages, including taking depreciation and some expense write-offs.
But there are downsides. Owning a rental property isn’t for the faint of heart. Unreliable tenants, decreasing property values, the cost of maintaining and repairing properties, as well as fees for rental property managers can all take a bite out of your rental income stream.
6. Capital Gains
Another important income stream can come from capital gains. You incur a capital gain when you sell an asset for more than what you originally paid for it. For the purposes of capital gains, an asset usually means an investment security such as a stock or bond. But it can also encompass possessions such as real estate, vehicles, or boats. You calculate a capital gain by subtracting the price you paid from the sale price.
There are two types of capital gains — short-term and long-term.
• Short-term capital gains are realized on assets you’ve held for one year or less.
• Long-term capital gains are earned on assets held for more than a year.
The tax consequences are different for each type of capital gain. Short-term gains are taxed as ordinary income, while long-term capital gains may be taxed at a lower rate.
Keep in mind, however, that capital losses can happen too. That’s when a capital asset is sold for less than its original purchase price. While it’s never pleasant to experience losses, there can be a small silver lining in this case. You may be able to claim a capital loss deduction from your annual capital gains.
7. Royalty Income
Royalty income comes from an agreement allowing someone to use your property. These payments can come from the use of patents, copyrighted work, franchises, and more.
Some examples: Inventors who license their creations to a third party may receive royalties on the revenue their inventions generate. Celebrities often allow their name to be used to promote a product for royalty payments. Oil and gas companies may pay landowners royalties to extract natural resources from their property. Musicians may earn royalties from music streaming services.
Royalty payments are often a percentage of the revenues earned from the other party using the property. Many things impact how much royalty is paid, including exclusivity, the competition, and market demand. How royalty payments are taxed can also vary, depending on the type of agreement.
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The Takeaway
Understanding the seven general income streams (such as earned, dividend, and rental income) can help you make the most of your financial planning. Earning income from any of these sources can provide stability and help you achieve long-term goals, such as saving for retirement. Because some types of income have unique tax implications, it can be important to check with your tax advisor about any tax consequences that may exist.
Aside from earned income, interest is a type of income many people receive. And seeking out the best possible interest rate can be a solid way to enhance your earnings; looking for a high-yield bank account may be a good place to start.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
FAQ
What are the seven common types of income?
The seven common types of income are: earned income (money earned for work); business income (money received for products or services sold); interest income (returns from interest-bearing financial accounts); dividend income (payments from companies to stockholders as a share of profits); rental income (income earned from rental payments on property owned); capital gains (profit incurred when selling an asset for more than its purchase price); and royalty income (payments from licensing property like patents or copyrighted work).
What are the three main types of income?
The three main types of income include: active income (earned from performing a service like a job), passive income (generated from ventures like rental properties where you are not actively involved) and portfolio income (derived from investments such as stocks and bonds). These categories are distinguished by how the money is generated and how the income is taxed.
What are the four main income categories?
From a personal finance perspective, the four main income categories are: active income (money earned directly from a job or services rendered), passive income (recurring income from ventures in which you are not actively involved), portfolio income (earnings from investments like stocks, bonds, and mutual funds), and government income assistance (financial aid from the government for those who qualify).
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