What Is Non-Passive Income?

By Indeed Editorial Team

Updated February 22, 2021

Published December 7, 2020

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

When talking about compensation, most people use the term "income" to describe a variety of types of pay. However, there's a substantial difference between passive and non-passive income. Understanding these differences takes a bit of education, but it's worth knowing to ensure you're making the most of any compensation you receive and properly filing the necessary taxes.

In this article, we explain what non-passive income is, describe how non-passive income functions, consider the types of non-passive income, list a few examples of non-passive income, highlight the differences between passive and non-passive income and offer considerations regarding non-passive income and losses.

Related: Passive Income Opportunities To Earn Extra Money

What is non-passive income?

Non-passive income is any income you receive that does not qualify as passive. This distinction is important when filing taxes, as there are loss and write-off rules guiding how you classify your earnings. Non-passive income constitutes a variety of pay sources, including the wages you earn from working for an employer.

Related: Gross Income: Definition and How To Calculate It

How does non-passive income work?

Non-passive income is a descriptor for certain types of income, which impact how you're taxed. Non-passive income is an important distinction for tax filing. As a rule, you cannot offset non-passive income and losses with passive income and losses, just as you cannot offset passive income and losses with non-passive income and losses. Any losses you claim on your income must coincide with only the related type of income.

Related: How To Calculate Your Annual Income

What is considered non-passive income?

Non-passive income constitutes a number of different money-making endeavors. Common forms of non-passive income include:

Active income

Active income is what most people think of when they hear the word "income." It's the compensation you receive for actively performing a job. Usually, active income includes all types of employment-related payment, including hourly wages, annual salary, tips and commissions.

Business income

For people who fully own or partially own a business, the income or losses from that business count as non-passive income. There are several particular types of business structures, and only some of them require business owners to report their company's profits and losses on their individual tax returns. If you have a sole proprietorship or are part of a partnership, then you have business income to report as non-passive income.

Active management

Active management income is another type of non-passive income. Active management refers to a method of stock investing. With active management, you, the investor, try to outperform the market by making a series of active purchases and sales to maximize your return on investment. This differs from passive management, or the investment in index funds, that mirrors the track of the overall stock market and assumes that, eventually, your investment will provide a profit with no additional oversight.

Related: How To Calculate Operating Income

Examples of non-passive income

Non-passive income can either come from active income sources, business income and profits or active investment management. Review some specific examples of non-passive income for a deeper understanding of the term:

  • Business activity: If you engage in business activity or stock trading related to the business activity during the tax year, the profits you generate are a type of non-passive income.

  • Active stock trading: Any active stock trading in an attempt to earn profits is an example of non-passive income.

  • Home rental: If you rent part of your home, like a room or other area, that's often considered non-passive income rather than passive income like that of an entirely separate rental property.

  • Wages: Any wages you earn, from hourly or salaried work, plus tips or commissions, are considered non-passive income.

Passive vs. non-passive income

Non-passive income stands in stark contrast to passive income. While you can earn non-passive income through a variety of activities, you generally earn passive income through investing in projects that require little to no oversight or additional time and energy. Common examples of passive income include:

  • Owning a rental property

  • Selling an e-book or other informational product

  • Performing affiliate marketing

  • Passively investing in the stock market

  • Lending money to a peer

  • Earning dividends from stock ownership

  • Gaining interest on a savings account

You can earn both passive income and non-passive income in a range of ways, some of which may initially appear very similar. When distinguishing between passive and non-passive income, consider these factors:

  • Activity: The manner in which you earn the money helps categorize whether it's passive or non-passive. Passive income is the result of a single action that continues to provide a financial return, like purchasing a house you rent out, while non-passive income is the result of a consistent commitment, like working at your job every day.

  • Taxes: The largest and most important distinction between passive and non-passive income is how these pay streams are taxed. You can offset passive income and passive losses together, and you can offset non-passive income and non-passive losses together, but you cannot combine passive and non-passive income and losses for a more favorable tax bill. Consult a tax professional for more information on how to appropriately categorize your income on your tax return.

Related: 44 Ways To Supplement Your Income

Non-passive income and losses

Accurately defining and categorizing your income and losses on your tax return is important because filing losses can result in tax cuts for compensation. Since you cannot legally use a non-passive loss to offset a passive profit, knowing how to properly classify your income is vital.

For example, consider you have a non-passive income stream through your actively managed stock investments. This year, you took a loss on your investment, meaning you lost more money than you invested. However, you also have a passive income stream through a rental property. You made more money than you lost this year on your rental property. You cannot use the loss from your actively managed investment to offset the increased taxes you have on your profits from your rental property since they're different types of income.

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