Understanding active income
Active income is defined as income that is earned as a direct result of performing a service or participating in a business or activity. It involves exchanging time and labor for money, requiring continuous effort to generate earnings.
Here are some common examples of active income:
- Salaries and Wages: These are the most typical forms of active income, where you receive a fixed payment for your work based on a set schedule, or an hourly wage for the hours you work.
- Freelancing and Consulting Services: Income earned from providing services as an independent contractor, such as writing, graphic design, web development, or business consulting, falls into this category.
- Business Profits: For those who actively own and operate a business, the profits generated are considered active income. This involves direct involvement in daily operations and management.
- Tips and Commissions: Professionals in sales, for instance, often earn income through commissions based on their performance and sales figures.
- Gig Work: Participation in the gig economy, such as driving for rideshare services or making deliveries, also counts as active income because it involves providing a service for payment.
- Bonuses: Bonuses tied to performance metrics or achieving specific goals are also considered active income as they are directly linked to your efforts and achievements.
Key differences between active and passive income
The main distinction between active and passive income lies in the level of involvement required to generate the income:
- Active income requires ongoing participation and effort, meaning the income stops when the work stops.
- Passive income is earned with minimal ongoing effort after an initial investment or setup, according to SoFi. Examples include income from investments like stocks, rental properties, or royalties.
Understanding the difference between active and passive income is important because it can impact tax treatment and financial planning. Active income is generally taxed at ordinary income rates, while some types of passive income may receive more favorable tax treatment, such as long-term capital gains or qualified dividends.
In essence, if you're actively trading your time and labor for money, that's active income.
