What it is:
Passive income is
How it works (Example):
Let's say John Doe is a limited partner in his cousin's pizza chain. He receives payments from this endeavor, and because these payments aren't wages, John Doe is receiving passive income.
Dividends and interest can be construed as passive income.
Taxpayers usually need to fill out IRS Schedule C, D, E, or F to report passive income.
Why it Matters:
Passive income is a great way to build wealth and create during retirement. However, passive income receives different tax treatment than wages do. Sometimes, taxpayers try to construe income as passive income so that they can deduct losses associated with the stream of income too. (Passive losses are only deductible in amounts equal to passive income.)