How is Passive Income Taxed?

How is Passive Income Taxed?

There are two types of income. One of them is the salary you get or the direct earnings that you make. The second type of income is passive income. The passive income is the money that you earn without actively engaging in an activity or trade. Any investment income, dividend, capital gains, or even interest income is considered a passive income. You would have heard this word, especially while filing tax returns. During the filing, the people are requested to give the details of their passive activities to be taxed appropriately.

The truth is that passive income is taxed very differently when you compare it with regular income. It should also be noted that passive losses are only deductible against passive income. The passive losses need to be carried forward, and they need to be deducted against the future passive income. To file the income tax return correctly, it is essential to understand the rules around passive income. Let us find out more such details about the passive income and the taxation policy around it.

What is considered as Passive Activity?

As per the law, a passive activity is anything where the applicant is not directly involved in. For example, the rental income is considered to be a passive income. There are certainly some exceptions here, but in general, the rental income is passive. In addition to this, the income earned with the investments. Apart from this, the individual may even earn passive income if he doesn’t meet the standard for material participation as defined by the low. It should be noted that material participation is a test that is provided by the IRS. 

In the test, the standard inclusions are listed below. 

  • Working in an activity for over 500 hours.
  • Being the only participant in the business. 
  • Working a minimum of 100 hours and working as much as other individuals working in the business.
  • Involvement in material participation for five years out of the last ten years.
  • For personal businesses, material participation is capped at three previous years.

How is Passive Income Taxed?

If you have determined whether your income is active or passive, you can proceed with the taxation rules. The test mentioned above is the best way to determine the nature of income. If you do not qualify for the test, you qualify for the loss of $25,000. If you qualify for the test, you will be able to take a limited about of loss every year. The loss can be carried over until the income has been offset.

The tax rate for the current year is lower because of the act signed by President Trump. The short term gains are taxed between 10% & 37%. The long term passive income tax rate has three categorizations. Depending on your income bracket, you will be taxed 0%, 15%, or 20%. The long term passive income has a lower tax when compared with the short term passive income. It should be noted that the income generated from the real estate is eligible for a 100% depreciation. To get a better picture, it is better to get some professional help because we are sure that you do not wish to make any error while cumulating the passive income details.


I am Finance Content Writer . I write Personal Finance, banking, investment, and insurance related content for top clients including Kotak Mahindra Bank, Edelweiss, ICICI BANK and IDFC FIRST Bank. Linkedin

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