What is passive income? There are many different definitions that are thrown around depending on where you look. Some critics argue that there is no such thing and that anything claiming to be must be a scam. On the other hand, there are a large group of people who misinterpret the terminology and claim anything earned online is passive. The real definition fits somwheres in between these two extremes.
Let’s check out a few well respected online sites to get a better understanding of what some of the experts are saying.
The Simple Dollar says that it is – “… any source of sustained income that you earn without any additional work.”
Wise Geek states that these earnings are “… a type of income that once setup, requires no further input from the recipient.”.
Moolanomy definition states “… This is the opposite of active income. Once you stop spending time on these income sources, the income flows don’t necessarily stop. Of course, there are varying degree of passitivity and it’s desirable to have highly passive alternative income sources.”
IRS Definition
The United States Department of the Treasury has it’s own classification that is probably different than what you have heard in the past. According to the tax classification –
Passive income can only be generated by a passive activity. Just because the taxpayer did not work for the income does not mean it is passive. There are only two sources for passive income:
1. a rental activity; or,
2. a business in which the taxpayer does not materially participate.
The federal government goes on to say that the following types of income cannot be considered passive -
- Interest Income
- Dividends
- Royalties
- Gains on Stocks and Bonds
- Annuities
- Lottery Winnings
- Salaries
Definition of “passive” & “income”
Take a look at the definitions of what the words “passive”, “income”, and “passive income” mean according to Dictionary.com –
passive – “not participating readily or actively”
income – “the monetary payment received for goods or services, or from other sources, as rents or investments”
passive income – “Earnings an individual derives from a rental property, limited partnership, or other enterprise in which he or she is not actively involved”
The Passive Family Income Definition
It is absolutely necessary to honor and abide by the IRS classification of passive income for tax reporting purposes. However, that does not mean that we cannot consider dividend or interest income as passive for example. Regardless of how the income is classified for tax reporting purposes – a passive form of income requires less of your time so that it can be used on something else.
Here are 3 traits that can help clarify the definition listed above -
- Upfront Investment – An initial upfront investment of time is required. There is no such thing as a get rich quick method for creating this form of cash flow stream. Instead, it takes an initial investment of your time to build a successful and sustainable passive income stream.
- Limited Participation – Once a passive income stream has been established there is still some limited participation required. While the level of participation may vary, it is virtually impossible to completely ignore this type of income stream. The key however is that this type of income does not require full time participation by you.
- Potential for Recurring Income – Creating passive income has the potential but does not guarantee continuous recurring income. Once the initial time investment is made, the income stream has the possibility to earn income over and over for years to come.
What is your definition of passive income? I would love to hear back from you and will consider adding your definition to this list (positive or negative).
Related posts:
- 18 Passive Income Opportunities to use your Tax Refund on
- How to Identify the Best Passive Income Streams
- Top Passive Income Streams You Should Consider
- What is Holding Back My Passive Income Earnings?
- How To Earn Passive Income At Home
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Passive income to me, is once you set something up, you can leave it on ignore after that and the income (or savings) continue without any help from you from then on. For instance, our mutual fund that we have our IRAs in offered us the opportunity to go paperless and in so doing we wouldn’t have to pay the yearly maintenance fee of $25 per account. I signed up hubby and I and so now year after year we save (or earn however you look at it) $50 a year. That is truly passive and I consider it income as otherwise they would be taking that money out of the account each year diminishing the value of the fund (which unfortunately isn’t that much anyhow) so now the fund total invested isn’t going down and the money that isn’t being paid out, is also being reinvested each year. Passive. If I had to sign up for this every year it wouldn’t be passive, it would be a pain in the neck. I try to look for anything like this that I can as we have very limited funds so each way we can find to NOT spend money and keep the not spending going over time without thought or effort on our part is my passive income.
I think you covered it very well.
If you want to be really strict about it, there is nothing truly passive, unless somebody gives you a gift of 30-year treasury bonds. You have to research, you have to manage, you have to acquire. (You have to earn the money to invest….)
When it comes down to it, what most of us mean by Passive Income is that it is an investment that may involve time rather than money. As with all investments, you may or may not reap the rewards later, but the promise and possibilities of the reward for the time is better than the guaranteed reward you get for ordinary fee-for-service or wages.
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Passive income is where it’s at, to me its when you make an initial time,education, and money committment, but then (hopefully) the time, education, and money committment diminish as time goes on. Needless to say, maintenance and repair is always required of most passive income, but hopefully not as much as a full time job. Some types that I am currently involved with are building a pension, tax-deffered savings, taxi-medallion leasing, and rental property. What I am also trying to do now is also patent something, and hopefully license it or sell it off; I’d prefer to license it because to me slow nickels are better than fast dimes. Wish I could write the Great American Novel- now that would be EXCELLENT passive income, as it requires less up-front money than other ventures, but much creativity and sweat equity to get it published. In any event, true passive income is good on at least five levels:
1) It is often independent of your job, so eventually you can walk away from your job (except of course pensions).
2) It often has a beneficial tax structure, for example allocation of income in a C corporation to less taxed family members.
3) It is a transferable asset, so once you build freedom for your family, you also likely purchase it for at least your children.
4) Often, it is inflation protected, so inflation becomes your friend as assets inflate but get paid off with cheaper dollars. (Again, this is not true with fixed pensions or fixed rate investments.)
5) The psychological freedom you attain as you daily increase towards your goal of complete financial freedom from the whims of a capricious boss. This, to me, is worth more than any amount of money, but unfortunately is only purchased with money.
Unless there is some long term passive income to be generated, I refuse to trade my hours for dollars, and within 11 years myself, my wife, and our two children should be financially free forever.
@Antolin – Wow, that is a great list of advantages in building passive income. It looks like you are well on your way to reaching financial freedom! Best of luck to you.
Thanks pfincome, it hopefully will all come together. Pretty exciting time, as well this year. Putting together our first 1031 exchange, to upgrade from my wife’s handicapped accessible medallion to a regular medallion, and defering, ideally forever, the capital gains. Deal should be 1/2 done on Monday, with the sale of the first medallion, and hopefully completed within the required 180 day timeframe.
It is basically an everyday financial battle to gain and keep your financial freedom, as this is a foreign concept to most people. Some days there are major battles, like Monday’s upcoming fight to keep away the Capital Gain Ghoul, and other days it is simply a small decision to make coffee at home rather than buy outside. But little decisions, and the few big ones, win the war, and I believe that a man can influence his children down to the fourth generation.
It is my fervent wish and dream that down to my great-grandchildren do not have to worry about housing, eating, an education, or having to trade dollars for hours. Not that I want them to do nothing or become like the idle rich who feel so guilty that to assuage their shame over their inherited wealth they feel the need to dream up new taxes on us regular joes, but rather that they don’t HAVE to dance to anyone else’s tune, and can choose their profession that they feel will enable them to best serve humanity and provide for their family.
Best of luck to you as well,
Antolin Du Bois
You summed this post very well and offered some good information to someone searching for passive income. It gives them a better opportunity to find out what passive income is truly is.
@Jennifer – Thanks. How would you define passive income?
Sadly, I don’t have any BIG forms of passive income… but I do have a few… Its only a few dollars a month, but its something.
We get small bits of interest from CD’s and a few savings accounts where our emergency fund is kept.
Eventually when I can open my new Roth IRA, the mutual fund i’m planning of purchasing has a yield and some dividends so its a bit of passive income that i’ll roll into new purchases.