Posted on | June 1, 2013 | 13 Comments
There are essentially three types of income passive, earned and portfolio. When filing your income tax at the end of the year each one of these types of incomes have different taxes. This is why it is important that you completely understand the difference between each one.
Below is the definition of each one and the category they are in.
This is the simplest type of income to identify. This is income that is earned from having a job, owning a business, being involved in a business or any type of activity that you are paid for. Earned income involves wages, salary and tips.
This is the most common type of income. Earned income has a range of anywhere from 15% to 20% which adds up quickly. This type of income is also subject to various other taxes such as Medicare and Social Security. With these types of taxes earned income can be taxed up to as much as half of the gross amount of every paycheck. One big disadvantage of earned income is the total amount of deductions that can be taken. Earned income is not as plentiful as other types of income and is often referred to as “active income. Before filing your income tax it’s advised to consult a tax specialist about which types of deductions you qualify for. The more deductions you use the more you can get back on your tax refund.
Passive income is income that is earned from activities that you don’t always participate in such as business partnerships or real estate. In 1986 there were special rules that were passed regarding passive income that restricted exactly how much you can make. However, you can still earn approximately $25,000 and if your income is lower than $150,000 and also are active in real estate that gives you a passive income. This amount can range between $100,000 and $150,000. However other than this exception you are still allowed to earn between $100,000 and $150,000 in losses if there are other losses which cannot be claimed they can be carried forward until the property is disposed of. Other types of passive income including real estate can be claimed on Form 1031 if the proceeds are going to be used to purchase other properties or other forms of passive income.
This form of income comes from a portfolio which includes interest, capital gains, dividends or royalties. Each type of portfolio income is taxed differently. For example, capital gains are taxed at a rate of between 10% and 20% if held for longer than 12 months. Capital gains that are held for less than that are taxed as income. However, even though it is considered income at that point it still is not subject to Medicare or Social Security. One big advantage with capital gains is that it can be used to offset other investments. For example if one stock gained $12,000 and another lost $10,000 you could use capital gains to offset $2,000.