Key Difference – Passive vs Non-passive Income
The key difference between passive and non-passive income is that passive income refers to the income resulting from rental activity or any other business activity in which the investor does not materially participate whereas non-passive income consists of any type of active income, such as wages, business income or investment income. Distinguishing between these two types of income is important since there are specific types of incomes that belong to each category. Furthermore, these are also treated differently for tax purposes.
CONTENTS
1. Overview and Key Difference
2. What is Passive Income
3. What is Non-passive Income
4. Side by Side Comparison – Passive vs Non-passive Income
5. Summary
What is Passive Income?
Passive income is the income resulting from rental activity or any other business activity in which the investor does not materially participate. In general, if an investor receives income (or losses) from a business but is not an active participant in the business, it will be categorized as a passive income. Some examples of passive income includes,
- Earnings from a business that does not require direct involvement of the owner
- Interest income from deposits and pension
- Dividend and capital gains from securities or commodities
- Royalties earned on intellectual property
Passive income is taxed by the Internal Revenue Service (IRS) where they implement a test for material participation. Thus, according to IRS, if an investor dedicates more than 500 hours to a business activity where he or she is entitled to a profit from; this will be classified as material participation. Passive income can be taxed up to 15%, which is considerably a lower rate compared to non-passive income. Furthermore, passive losses cannot be offset against non-passive income for tax purposes. Passive income generating has gained much popularity in recent times and many individuals use the concept to make an extra income.
Figure 01: Dividends and capital gains are two main types of passive income for investors
What is Non-passive Income?
Non-passive income consists of any type of active income, such as wages, business income (income resulting from a business activity) or investment income. Simply put, non-passive income consists of any income that cannot be classified as passive. Non-passive losses include losses incurred in the active management of business. Non-passive income and losses are usually declarable and deductible in the year incurred. Some examples of non-passive income includes,
- Wages, salaries, bonuses, commissions or other payments for services rendered
- Profit from a trade or business in which you are a material participant
- Gain on the sale of assets used in an active trade or business
- Income generated from intangible property
Non-passive income and losses cannot be offset by passive losses or income in tax calculations. Up to a limit of 35% tax may be applicable for non-passive income.
What is the difference between Passive and Non-Passive Income?
Trend Analysis vs Comparative Analysis |
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| Passive income refers to the income resulting from rental activity or any other business activity in which the investor does not materially participate. | Non-passive income consists of any type of active income, such as wages, business income or investment income. |
| Types | |
| Rental income, interest income, dividend and capital gains are common types of passive income. | Non-passive income includes active income, business income and investment income. |
| Tax Rates | |
| Passive income can be taxed up to 15%. | Tax limit for non-passive is 35%. |
Summary – Passive vs Non-passive Income
The difference between passive and non-passive income basically depends on the type of income in consideration, since some types of income are clearly classified as passive income and others as non-passive income. ‘Material participation’ becomes an important phenomenon in determining whether a particular stream of income is passive or non-passive. While non-passive income is primarily generated through business activity, individuals can use many creative ways to earn passive income as an additional stream of revenue.
References:
1.”Passive Income.” Investopedia. N.p., 02 Sept. 2015. Web. 17 Apr. 2017.
2. Kahler, Rick. ” Tax rates vary depending on ‘ordinary,’ ‘passive’ income.” Rapid City Journal. N.p., 29 Apr. 2012. Web. 17 Apr. 2017.
3. “Active Income.” Investopedia. N.p., 17 Nov. 2003. Web. 17 Apr. 2017.
4. “Passive v Non Passive Income | St Louis Tax Planning.” Anders CPAs Advisors. N.p., 09 Jan. 2017. Web. 18 Apr. 2017.
Image Courtesy:
1. “Percent of Income from Capital Gains and Dividends (2006)” By Guest2625 – Own work (CC BY-SA 3.0) via Commons Wikimedia
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