How Is Passive Income Taxed?

Yes, residual income is usually taxable. So long as you are making enough money from any source, you will most likely need to pay taxes on it. The only income you typically don’t have to pay taxes on is income below a certain yearly value, or income that the IRS deems as passive income.

Passive income, often called residual income, is usually taxable. Traditionally, when it comes to small business finances, so long as you are making enough money from any source, you will most likely need to pay taxes on it. The only income you typically don’t have to pay taxes on is income below a certain yearly value, or income that the IRS deems as passive income.

In this article, we will explain how is passive income taxed, talk about the different types of income and advise what you need to pay taxes on.

Low Passive Income Tax Bracket Threshold

So how is passive income taxed? If you run a residual or passive income business, such as a blog, then you may be exempt from paying taxes on the income the blog earns, depending on how much income you earn, both from the blog and from other work. If your total income is less than $12,000 in a year and you are single—or it is less than $18,000 and you qualify as head of the household—then you most likely won’t pay federal taxes on that residual income. This is because the U.S. government typically doesn’t tax what it classifies as low-income earners.

It’s probably unlikely that you’re winning bread for your family by running a blog that makes less than $18K. But, let’s say you’re fresh out of college, or still in college, and you live with your parents. If you earn less than $12,000 from your residual income operation, then you most likely won’t have to pay federal taxes on that. This is true, however, of any type of income. You could be scooping ice cream on the weekends or driving for Uber. But, if you’re listed as a dependent and you make less than $12,000 in a year, you probably won’t pay federal taxes on that income.

Passive Income Tax and Write-Offs

What’s important to add is that most residual income businesses require some sort of financial investment to get off the ground. If you’re running a blog, you probably need to pay for your web hosting and design software, the computer that you create the content on, and a camera to take pictures for your blog. Altogether, say you spend about $2,500 on your blog across the year. You can write off these purchases as business expenses when filing your taxes. In this case, you may end up making more than $12,000, or $18,000 as head of household, but ultimately not have to pay passive income tax because your business expenses will reduce your taxable income. It’s not guaranteed, but it is possible.

Should I Pay Passive Income Tax?

The IRS considers the income that comes from businesses where you don’t actively participate as passive income. If the only type of income you are making is—according to the IRS—passive income, then you may end up not having to pay passive income tax on it.

Examples of When You Don’t Have to Pay Passive Income Tax

Here’s what the IRS looks at when determining if income is passive. If you answer yes to any of these criteria, your income is not passive according to the IRS:

If you’re the sole proprietor of a business during the year

If you work at least 500 hours making the income in a year

If you have been involved in operations on a regular basis for five of the past 10 tax years or three of the previous tax years

If you work at least 100 hours and as much as anyone else at the business during the year

As you can see, paying zero residual passive income tax on your passive income isn’t feasible

How Is Passive Rental Income Taxed?

Many property owners or people considering investing in a property to make passive income ask how is passive rental income taxed?” Residual income that is made from rental properties is typically taxed just like regular income. So, let’s say you make $1,000 a month from a rental property, and your combined take-home with your other sources of income is $150K at the end of the year. You would pay federal taxes on the $1,000-a-month rental property based on the tax bracket that your $150,000 take-home puts you into.

There is one major difference between the taxes you pay on residual income from rental properties versus the taxes you would pay on salaried income. Your rental property may depreciate over time and you can write that off on your taxes. You also can write off the costs for maintenance and repairs, which are usually frequent. These deductions can make rental property a very profitable investment.

Residual or passive income is a great addition to anyone’s financial earnings. When discussing passive income tax, it’s important to know that the IRS has a very specific definition of what passive income is. By having a good understanding of your overall finances and the U.S. tax code, you can at best put yourself in a situation where you might not have to pay taxes on all your income. At the very least, understanding the U.S. tax code can help keep you from landing in hot water with the IRS.

Low Residual Income Tax Bracket Threshold

If you run a residual income business, such as a blog, then you may be exempt from paying taxes on the income the blog earns, depending on how much income you earn, both from the blog and from other work. If your total income is less than $12,000 in a year and you are single—or it is less than $18,000 and you qualify as head of the household—then you most likely won’t pay federal taxes on that residual income. This is because the U.S. government typically doesn’t tax what it classifies as low income earners.

It’s probably unlikely that you’re winning bread for your family by running a blog that makes less than $18K. But, let’s say you’re fresh out of college, or still in college, and you live with your parents. If you earn less than $12,000 from your residual income operation, then you most likely won’t have to pay federal taxes on that. This is true, however, of any type of income. You could be scooping ice cream on the weekends or driving for Uber. But, if you’re listed as a dependent and you make less than $12,000 in a year, you probably won’t pay federal taxes on that income.

What’s important to add is that most residual income businesses require some sort of financial investment to get off the ground. If you’re running a blog, you probably need to pay for your web hosting, design software, the computer that you create the content on, and a camera to take pictures for your blog. All together, say you spend about $2,500 on your blog across the year. You can write off these purchases as business expenses when filing your taxes. In this case, you may end up making more than $12,000, or $18,000 as head of household, but ultimately not have to pay federal taxes because your business expenses will reduce your taxable income. It’s not guaranteed, but it is possible.

Do I Pay Taxes on Passive Income?

The IRS considers income that comes from businesses where you don’t actively participate as passive income. If the only type of income you are making is—according to the IRS—passive income, then you may end up not having to pay federal taxes on it.

Here’s what the IRS looks at when determining if income is passive. If you answer yes to any of these criteria, your income is not passive according to the IRS:

• If you’re the sole proprietor of a business during the year

• If you work at least 500 hours making the income in a year

• If you have been involved in operations on a regular basis for five of the past 10 tax years or three of the previous tax years

• If you work at least 100 hours and as much as anyone else at the business during the year

As you can see, paying zero taxes on your passive income isn’t feasible.

Property Investment Residual Income

Residual income that is made off of rental properties is typically taxed just like regular income. So, let’s say you make $1,000 a month from a rental property, and your combined take-home with your other sources of income is $150K at the end of the year. You would pay federal taxes on the $1,000-a-month rental property based on the tax bracket that your $150,000 take-home puts you into.

There is one major difference between the taxes you pay on residual income from rental properties versus the taxes you would pay on salaried income. Your rental property may depreciate over time and you can write that off on your taxes. You also can write off the costs for maintenance and repairs, which are usually frequent. These deductions can make rental property a very profitable investment.

Residual or passive income is a great addition to anyone’s financial earnings. Often, residual income and passive income are used interchangeably. When discussing taxes, it’s important to know that the IRS has a very specific definition of what passive income is. By having a good understanding of your overall finances and the U.S. tax code, you can at best put yourself in a situation where you might not have to pay taxes on your all of your income. At the very least, having an understanding of the U.S. tax code can help keep you from landing in hot water with the IRS.

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Author Note: The tax information in this article is up to date as of May 2019.