Passive vs. Non-Passive Income: What’s the Difference?

Effective financial planning centers on two main types of income: passive and non-passive. Knowing how each type applies to your financial situation, and how each is taxed, can improve overall tax planning and money management. With this knowledge, you can make more strategic decisions and potentially reduce your tax liability.

Talk to a financial advisor to learn about what you can do to reduce your tax liability on investments. Connect with your advisor matches today.

Passive vs. Non-Passive Income

Passive income is money earned with minimal effort or active involvement. It’s income generated from investments, businesses or assets in which the earner is not actively participating on a regular basis. Passive income typically requires upfront time, effort or capital to create or acquire the income-generating source, but once established, it can continue to generate income with little ongoing effort.

Non-passive income, often referred to as active income, is income earned through your active participation in work, services or business activities. This type of income is typically associated with traditional employment or actively running a business.

Types of Passive Income

Passive income streams can provide earnings with minimal ongoing effort, making them a popular choice for building financial security. Here are some common types of passive income:

Rental income: Earnings from leasing out property, such as homes, apartments or commercial spaces. It requires an upfront investment but can generate consistent cash flow.
Dividend income: Regular payments from owning stocks in dividend-paying companies. This income depends on the company’s performance and dividend policies.
Royalties: Payments received for intellectual property like books, music or patents. Royalties provide ongoing income as long as the asset remains in demand.
Peer-to-peer lending: Interest earned by lending money through online platforms. Returns vary based on the loan’s risk level.
Online content revenue: Income from ads, affiliate links or subscriptions tied to blogs, YouTube channels or other digital platforms.

Types of Non-Passive Income

Non-passive income requires active involvement, often involving consistent effort to maintain and grow. Here are common types of non-passive income:

Salaries and wages: Compensation for full-time or part-time work, typically earned through employment contracts or hourly work arrangements.
Freelance or gig work: Earnings from short-term or project-based jobs, such as writing, graphic design or ridesharing services. This type of income often depends on the worker’s time and skills.
Business profits: Income from actively managing or running a business, such as retail shops, restaurants or service providers. Success often hinges on the owner’s involvement.
Consulting fees: Payments for providing expert advice or services in a specific field, often tied directly to the consultant’s time and expertise.
Sales commissions: Income earned based on selling products or services, commonly seen in industries like real estate or insurance.

Tax Treatment of Passive and Non-Passive Income

A woman comparing passive vs. non-passive incomes.

Non-passive income, such as wages, freelance income or business profits, is taxed as ordinary income at progressive rates based on total earnings, currently ranging from 10% to 37%.

This type of income is also subject to payroll taxes, including Social Security and Medicare. For self-employed individuals, these taxes are paid through the self-employment tax, which covers both the employer and employee portions.

Despite the higher tax exposure, earners of non-passive income may qualify for a variety of deductions and credits, including the standard or itemized deduction and credits related to education, childcare and other expenses.

Passive income, such as investment earnings or certain types of rental income, may be taxed differently depending on the source. Qualified dividends and long-term capital gains are often taxed at lower rates than earned income. Rental income is generally taxed as ordinary income, though landlords can reduce taxable income through deductions for expenses like depreciation, maintenance and interest.

In some cases, passive income is also subject to the Net Investment Income Tax (NIIT), an additional 3.8% tax that applies to higher earners. The IRS also enforces passive activity loss rules, which limit the ability to use losses from passive activities to offset non-passive income.

Net Investment Income Tax and How to Avoid it

The NIIT is a 3.8% tax on certain investment income for high-income individuals, estate and trusts. It primarily applies to passive income, such as rental earnings, dividends, interest and capital gains, rather than non-passive income like wages or business profits. However, some income from businesses classified as passive activities can also trigger the NIIT.

Introduced as part of the Affordable Care Act, this additional tax applies to taxpayers with modified adjusted gross incomes (MAGI) above the following thresholds.

Net Investment Income Tax (NIIT) Thresholds in 2026

Tax Filing Status	MAGI Limits
Single or head of household	$200,000
Married filing jointly	$250,000
Married filing separately	$125,000
Qualifying widow(er) with dependent	$250,000
Estates and trusts	$15,650

To minimize or avoid the NIIT, individuals can consider strategies such as investing in tax-exempt municipal bonds, contributing to tax-advantaged accounts like IRAs or 401(k)s, and strategically timing the sale of investments to spread gains across multiple tax years.

Additionally, reclassifying passive activities as active through material participation may help certain business owners avoid the NIIT on related income. Consulting with a tax professional is advisable to ensure compliance while optimizing tax strategies tailored to individual circumstances.

Bottom Line

A woman examining receipts for passive and non-passive income.

Grasping the differences between passive and non-passive incomes is a cornerstone for effective tax planning. Having unraveled the qualifications for these income types, and their respective tax implications, and proffered some useful tips for managing your income and tax planning, you are well-equipped to navigate your financial journey.

Tips for Tax Planning

When you have multiple types of investments, it becomes vitally important to make sure you prepare your taxes accordingly. A professional advisor who specializes in taxes can be key to protecting your money in this way. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You may want to keep up to date with what you expect to pay in income tax every year. You can use SmartAsset’s free income tax calculator to estimate what you might owe.