What Is Passive Income?
Passive income is income generated from any business activity in which the earner does not participate. When people describe the dream of "getting rich quick" and "striking it big," they are usually describing a scheme that involves a component of passive income in one form or another.
Passive Income 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.
Other examples of passive income include rental income, dividends, and interest income. Passive income investments include CDs, bonds, and private equity investing.
Why Passive Income Matters
Passive income is a valuable 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.)
To report passive income, taxpayers typically need to fill out IRS Schedules C, D, E, or F.