A Guide To Passive Income And Tax Preparation

If you're considering setting up a passive income stream for yourself, then you're likely aware that taxes can play a large role in how much money you make. But why is this the case? And how exactly do taxes work with passive income?

This guide will provide an overview of the basics of taxation when it comes to passive income.  

What Counts As Passive Income?

Passive income refers to any money made from investments or activities that require minimal effort on your part. Examples include rental properties, dividend stocks, e-commerce businesses, royalties from books or other creative works, and more.

It differs from regular active income, which you earn through working a job, requiring very little maintenance once set up. That said, there is still some work involved in setting up these types of streams of revenue. And since they still bring in income, you have to pay taxes on them. 

Taxation Basics for Different Incomes

When it comes to taxation with passive income sources, there are two basic categories you should be aware of –– ordinary income tax and capital gains tax. Depending on the source of your passive income and your overall tax situation, you will likely find yourself subject to one or both of these types of taxes.

Ordinary income applies to earnings such as wages, interest payments, and royalties, while capital gains tax applies to profits made from investments such as stocks or real estate sales. In either case, understanding the applicable laws regarding taxation and keeping accurate records will help ensure that you get all the deductions available to you and don't end up paying more than necessary at tax time.

Tax Obligations and Deductions

For any passive income, you will be taxed according to the type of activity and your marginal tax rate — or the amount of taxes you pay based on your total taxable income for that year. For instance, if you earn a certain amount from rental properties and a different amount from stocks, you will need to calculate your total taxable income and then determine the applicable rate for each. 

It's important to keep in mind that the taxation for passive income is different from active income in some cases — and could be even more complicated if you have multiple sources of passive income.

Finally, it's worth noting that some forms of passive income — such as rental property income — can also be eligible for certain deductions, which may help you save on your taxes. 

To find out more, contact a company like Goranson Tax and Consulting Inc.