Definition

Passive Income

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What is passive income?

Passive income is the earning which does not require too much effort or hard work as it is derived via a rental property, any economic activity in which an individual is indirectly involved or a kind of limited partnership. Internal Revenue Service (IRS) treats passive income as separate from active income. Therefore, passive income is mostly taxable. However, the scope of passive income is vast because there are always innovative ideas like blog writing that can add to an individual’s income sans any tedious work.

There are a few who consider portfolio income (interests, dividends) as passive income. Passive income is also known as progressive passive income as its maintenance is easy. 

Summary
  • Passive income refers to the money earned in a way that requires little to no hard work or efforts.
  • Passive income is mostly taxable and can be earned through property rent or any other economic activity.
  • Taxpayers can claim a passive loss against earnings made from passive activities.

Frequently Asked Questions

How many categories of income are there? 

There are three kinds of income. These include:

  1. 1. Earned Income or Active IncomeEarned Income or active income is the most common income type. This is the income we receive for the work we do for others. In this category, time is traded for money. Example- salaried employee, freelancing projects, working as an advisor or consultant, working based on a number of hours in exchange for money. Taxation on earned income is higher as compared to the other two types. 
  2. Capital Gains Income:Capital gains income is also known as portfolio income. This is the income you earn when you sell a product or an investment at an amount higher than you paid for it. Capital gains is the difference between the selling price and purchase price. An example is you buy a bond or share and then later sell it for a higher price. 
  3. Passive Income:The is the money you earn from the existing assets, and this needs no extra effort. Examples can be real estate investment trust, dividend-paying stocks, rentals properties, websites, etc. However, it is to be noted that passive income cannot make you rich suddenly. So, one should stay away from such expectations. Though, consistent and profit-making passive income opportunities can help one amass wealth. It is also advised that to save efforts; one can group two or more passive opportunities into one, which also helps save time.

Discuss the different ways of Passive Income Investment?

These four methods include different levels of risk and diversification. Also, it is crucial to estimate the expected returns about a passive income opportunity and the potential for loss in terms of financial investment.

Role of Material Participation in business: 

Material participation is the method to determine if a taxpayer has actively participated in an income-producing activity regularly and contribute to passive income. 

The IRS formulated standard to identify material participation include:

  • If you are devoting over 500 hours to an economic activity from which you’re profiting, it is termed material participation.
  • If you have participated in an activity in “substantially all” of the participations for that financial year, that amounts to material participation.
  • If you have actively participated for around 100 hours, which is equal to any other person’s involvement in the activity, it is also termed material participation.

What are the pros and cons of passive income?

  • Having a stable passive income adds to our financial independence. It plays a vital role in enhancing the standard of living. And the best part is, you do not need to put in extra effort or hard work but must use the existing assets or skills to raise money. It is just creativity, where no capital investment is required. 
  • When one finds that it is time-consuming, one needs to spend time thinking about making money and actualising the real-life goals. However, it is worth your time because you need not always put in extra mind and effort to make profits for passive income. And most importantly, you do not have to spend capital from your pocket on these activities.  
  • Critics believe that passive income shares the same drawbacks as capital gains income because it requires you to spend the money you have to earn more out of it. Besides, if you create a website, for instance, to add to your passive income, it would require a considerable time commitment from you, and thus, it rules out the belief that passive income does not ask you to spend your time or money to earn income. 

Why is there a need to have a Passive Income?

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Passive income catches attention because you see extra money coming your way with minimalistic efforts. The wealth thus earned can help you fulfil your dreams in your life. In mostly all the jobs, the employees must work for the same number of hours throughout their life to earn their daily livelihood. During inflation, these employees are given the same wages even when they work overtime. In such a scenario, passive income compensates a daily worker’s earnings from his job, allowing them to work for fewer hours and helps in improving their standard of living. 

It is true that as we age, each one of us will retire one day, but it is next to impossible to survive without money. And one cannot stop working unless there is an alternative source of income. In such situations, it is good if you have passive income. Passive income is thus a pathway to lead a happy life when you do not have to depend on others to fulfil your needs. Not only it provides you with financial stability, but it also alleviates all your worries. Therefore, the importance of passive income is paramount, and it can always serve as a backup plan when a person loses the job or when a retiree outlives a retirement plan.