The examples and perspective in this article deal primarily with the United States and do not represent a worldwide view of the subject. (May 2014) (Learn how and when to remove this template message)
Passive income is income resulting from cash flow received on a regular basis, requiring minimal to no effort by the recipient to maintain it.
The U.S. Internal Revenue Service categorizes income into three broad types, active income, passive income, and portfolio income. It defines passive income as only coming from two sources: rental activity or "trade or business activities in which you do not materially participate." Other financial and government institutions also recognize it as an income obtained as a result of capital growth or in relation to negative gearing. Passive income is usually taxable.
Passive income differs from earned income and portfolio income in a variety of ways. Passive income is generally defined as a stream of income earned with little effort, and it is referred to as progressive passive income when there is little effort needed from the individual receiving the passive income in order to grow the stream of income. Examples of passive income include rental income and any business activities in which the earner does not materially participate during the year.
Passive income differs from active income which is defined as any earned income including all the taxable income and wages the earner get from working. Linear active income refers to one constantly needed to stay active to maintain the stream of income, and once an individual chooses to stop working the income will also stop, examples of active income include wages, self-employment income, material participation in an s corp, or a partnership. portfolio income is derived from investments and includes capital gains, interest, dividends, and royalties.
There are two kinds of passive activities:
- Any kind of cash flow property income – which includes profits from ownership of capital, rent from ownership of resources such as Rental income and incoming cash flow from property or any piece of real estate, and interest from owning financial assets.
- Trade or business activities in which one does not materially participate during the year.
- Royalties are payments made by one company (the licensee) to another company or person (the licensor) in exchange for the right to use intellectual property (book, music, video) owned by the licensor.
Forms of limited partnerships may be considered passive as long as the limited partner does not have any role in the company and they exchange their capital investment in return for a share of the activities profit.
In order to be considered a rental activity, tangible property is used by customers and the income paid from the activity comes from the amount paid for the use of the property and is not considered a rental if:
- The average period of customer use is:
- 7 days or less
- 30 days or less and significant personal services were provided
- "Publication 550 (2016), Investment Income and Expenses". www.irs.gov.
- "Topic 425 - Passive Activities– Losses and Credits". Retrieved 2009-06-18.
- "Earned Income | Internal Revenue Service". www.irs.gov. Retrieved 2018-05-12.
- "Earned Income vs Passive Income vs Portfolio Income: A Comparison - Just Ask Ben Why". Just Ask Ben Why. 2015-06-22. Retrieved 2018-05-12.
- "Publication 925 (2017), Passive Activity and At-Risk Rules | Internal Revenue Service". www.irs.gov. Retrieved 2018-05-12.