Understanding the IRS Guidelines on Passive Income
Passive income is an excellent way to make money while you sleep, travel, or work on other projects. However, it comes with a unique set of tax guidelines set by the Internal Revenue Service (IRS). If you’re earning passive income, it’s crucial to understand the IRS guidelines to avoid any legal trouble. In this article, we’ll break down the IRS guidelines on passive income, including what it is, how it’s taxed, and the different types of passive income.
What is Passive Income?
Passive income is money earned from investments, businesses, or rentals that require little or no effort to maintain. These sources of income can include rental properties, stocks, bonds, mutual funds, and businesses in which you’re not actively participating. Essentially, passive income is money earned without actively working for it.
How is Passive Income Taxed?
The IRS treats passive income differently than active income. Active income is money earned from employment or services offered. Passive income is taxed at a flat rate of 24%. This tax rate is lower than the regular income tax rate, which can be as high as 37%.
Different Types of Passive Income
There are many sources of passive income, and each has its unique tax guidelines. Here are some of the most common types of passive income:
Rental Income
If you rent out a property, the income generated is considered passive income. The IRS allows property owners to deduct expenses like property taxes, mortgage interest, repairs, and maintenance from their rental income. However, the IRS limits the amount of losses a taxpayer can claim from rental properties.
Dividend Income
Dividend income is money earned from stocks and mutual funds. The money generated from dividends is taxed at a lower rate than the regular income tax rate. The IRS treats dividend income as passive income.
Capital Gains
Capital gains are profits made from the sale of an investment. The IRS considers capital gains as passive income and taxes them at a reduced rate. The tax rate depends on the holding period of the investment. Investments held for over a year are taxed at a lower rate than those held for less than a year.
Royalty Income
Royalty income is money earned from the use of intellectual property like patents, copyrights, and trademarks. The IRS considers royalty income as passive income and taxes it at a flat rate of 24%.
Conclusion Passive income is an excellent way to make money while working on other projects. However, it’s essential to understand the IRS guidelines to avoid any legal trouble. In this article, we’ve broken down the IRS guidelines on passive income, including what it is, how it’s taxed, and the different types of passive income. By following these guidelines, you can ensure that you’re on the right side of the law while earning passive income.
