What is passive income? Well, there are many different definitions that are thrown around depending on where you look. Some critics argue that there is no such thing as passive income and that anything claiming to be must be a scam. While I don’t believe this type of income can be achieved quickly without some initial hard work and planning, I still think that passive income does exist in some form based on the PFI definition below.
Let’s check out a few well respected online sites to get a better understanding of what others are saying.
The Simple Dollar defines passive income as – “… any source of sustained income that you earn without any additional work.”
Wise Geek states that passive income “… is a type of income that once setup, requires no further input from the recipient.”.
Moolanomy defines passive income as “… 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 of passive income. 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 passive income is not any of the following types of income -
- 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 PFI Definition of “passive income”
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 of how PFI defines passive income -
- Upfront Investment – An initial upfront investment of time is required. There is no such thing as a get rich quick method for creating passive income. 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.
This is a working definition of the term “passive income” and will be updated periodically.
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).
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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.
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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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