Is there such a thing as passive income?

By Stew

I was looking over a list of ideas for generating so-called “passive” income when I was struck by the thought that there really is not such a thing as passive income. I think that many times we look at the way certain monies are earned and if those ways seem easier than the way our money is earned, we consider that money to be passive income. I once made a tax mistake regarding passive income, so there is definitely a difference in how the IRS treats active v passive income.

Let’s look at the list of revenue streams that the Internal Revenue Service considers to be passive:

Earnings from a business that does not require direct involvement from the owner or merchant.

What kind of business could this be? I struggle to think of a business that pays an owner or merchant who does or did nothing to improve that business. They might have had an idea for a product or a process that changed everything for that business. Maybe a person just came up with an idea for a logo like the Nike Swoosh. Either way, there is a concrete reason why they are getting that money. Some ideas are better than others.

Rent from property.

I have been a landlord. Furthermore, I have dealt with both poor landlords and outstanding landlords. Owning rental property is not passive. It take initial investment, recruitment of renters, risk, maintenance, record keeping and more. Owning property can be one of the most stressful ways to earn money that there is.

Royalties from publishing a book or from licensing a patent or other form of intellectual property.

Think about this for a second, income from writing a book is considered passive? Do you remember writing five or ten page papers in high school or college? Now multiply that amount of work times one hundred . . . writing a book is not passive income. It is true that the income might come after the book is finished, but that is almost worse. An author can eke out hundreds of pages of prose and never make a dime.

Earnings from internet advertisements on websites.

Again, this income can hardly be called passive. Does the IRS realize how much work it takes to put up a website that anyone wants to look at? Then there is producing advertisements that result in sales and those advertisements have to push a product that people actually want to buy. This is not easy work, my friends, not easy, not passive.

Residual income, repeated regular income earned by a sales person, generated from the payment of a product or service, that must be renewed on a regular basis in order to continue receiving its benefits.

So you finally produce a product that a person actually wants to purchase. Then, since the product delivers so well, they purchase it again. Sounds like a business where the operator is lounging around the house, drinking lemonade to me!

Dividend and interest income from owning securities, such as stocks and bonds.

There are times when such income is considered porfolio income rather than passive income, so in some cases, the IRS gets it right in recognizing that investments are not passive. They may accrue over time without physical labor on the part of the owner, but that money had to earned somewhere and if it is in the market, that income comes with risk. The investor must risk the cash in order to make a profit.

Pensions

This is an interesting one. This might be the closest thing to passive income since a pensioner really has nothing more to do than to pick up the check. However, a pension can only be earned after many years of labor.

This is the IRS list of passive income sources, however the IRS definition of what qualifies as passive income seems a bit fuzzy. The only unifying attribute seems to be that there is little manual labor being done anywhere on this list. On Friday, I plan to explore this idea a little further to get closer to the answer of whether or not there is such a thing as passive income.

Article by Stew

Photo by woodleywonderworks


7 Responses (including trackbacks) to “Is there such a thing as passive income?”

  1. Ken Says:

    It takes work to create passive income, no doubt. I think the real successful ones learn to do it cheaper and cheaper over time. They learn from mistakes.

  2. Walter Says:

    It’s nice that you have tackled this issue on its roots. Perhaps many are confused as the re real nature of “passive” income. It still involves participation and hard work. :-)

  3. Stew Says:

    Walter, that is the point, I think. There might be relatively easy ways to make a living, but nothing is truly passive.

  4. Glady Pacius Says:

    I just found this website a while back when a friend of mine suggested it to me. I’ve been a regular reader ever since.

  5. Blogging Banks Says:

    I think that interest and dividend income ( as well as pensions) are the closest to passive income. If you build a diversified portfolio consisting of 60% stocks/40% bonds using mutual funds for example or even individual securities, and you only treat dividends/interest as income, then your income is passive. As far as businesses that pay you, i think that if you buy one share of IBM, you are then considered to be a proportionate owner of the business. Thus any dividends that IBM delivers to you are considered passive income ;-)

  6. Jack_of_all_trades Says:

    I don’t know how can one categorize an income as “passive” if it involved an initial investment of time or/and money or if it involves a considerable amount of risk of devaluation. Buying a property to rent is nowadays one of the most risky investments, one must face the perspective of seeing his property devaluating day by day. It also involves investment in hiring the real estates firm that recruits the renters, the house maintenance, etc. Another “passive income” I tend not to regard as passive is the one from publishing a book or from maintaining a site. Who can qualify the amount of effort it implies and the investment in time, in sleepless nights, as passive? It’s like saying the building a portfolio of stocks and bonds, risking your money each time, generates effortless income. The physical labor isn’t everything, my friends from the IRS. When one makes good money investing his time and money to generate income, he cannot avoid to pay the income taxes .But when one loses, nobody gives him a cent to help him overcome his loss, and when they give it to him, it’s with a high interest. That’s live, nobody like losers because they can’t be the object of any taxes.

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