What You Need to Know About Passive Income and Paying Taxes
Most of us work hard to build ourselves up for the future, earning an active income to pay the bills and hopefully saving and investing money along the way. Taking earnings from active income and investing in passive income assets is key to unlocking your financial future. The Motley Fool reported that roughly 20% of Americans have some form of passive income, amounting to $4,200 annually, on average.
For You: 7 Things You Must Do To Start Making $1K a Month in Passive Income
Try This: How To Get $340 Per Year in Cash Back on Gas and Other Things You Already Buy
Passive income allows you to make your money work for you instead of just working to make money. It can also be a crucial form of supplementary retirement income. This way, you’re not relying solely on your Social Security income or retirement accounts.
Here’s what you need to know about the differences between passive and active income and the various tax implications involved.
Passive and Active Income Defined
According to SmartAsset, passive income is defined as unearned income. The most common forms of passive income are earnings from rental properties, investment returns, and interest on savings accounts.
On the other hand, Investopedia active income is defined as income received for performing work or performing a job or service. Examples include salaries, hourly pay, tips, wages, and commissions.
How Passive Income Is Taxed Differently
In most cases, passive income is taxed at your personal income tax rate. However, some factors can differentiate how passive income is taxed, which may result in more or less tax liability. Here are some examples:
Interest From Savings Accounts: You’ll owe your personal income tax rate on any interest earned from a savings account during a tax year.
Earnings From Rental Properties: Rental income is also taxed at your personal income tax rate. However, any operational expenses you incur as a result of owning the property are tax deductible. These can include many expenses related to a rental property, such as repairs and depreciation, mortgage interest, property tax, and other various operating expenses.
Stock Dividends: Stock dividends are taxed differently depending on their qualifications. Dividends classified as ordinary are taxed at your personal income tax rate but qualified dividends are taxed at the capital gains tax rate. In some cases, this can be a higher rate than your personal income tax rate.
More From GOBankingRates
Frugal People Love the 6 to 1 Grocery Shopping Method: Here's Why It Works
6 Cities Where Social Security Goes the Farthest for Retirees
This article originally appeared on GOBankingRates.com: What You Need to Know About Passive Income and Paying Taxes