Passive income is income that requires no effort to earn and maintain. It is called progressive passive income when the earner expends little effort to grow the income. Examples of passive income include rental income and any business activities in which the earner does not materially participate. Some jurisdictions’ taxing authorities, such as the Internal Revenue Service in the United States of America, distinguish passive income from other forms of income, such as earnings from regular or contractual employment, and may tax it differently.
There are three kinds of passive activities:
- Cash flows from property income, including profits from ownership of capital, rent from ownership of resources such as rental income, cash flows from property or any piece of real estate, and interest from owning financial assets.
- Trade or business activities in which one does not materially participate during the year.
- Royalties, which are payments made by one company (the licensee) to another company or person (the licensor) for the right to use the latter’s intellectual property (book, music, video) or patent. However, the Internal Revenue Service only considers royalties passive income when they are “not derived in the ordinary course of a trade or business.”
Some limited partnerships may be considered passive as long as the limited partner does not have any role in the company and exchanges their capital investment for a share of the activities profit.