Most of you all already know that you can earn income from many different ways. But maybe you didn’t know the actual categories each income source belongs too. I wanted to share with all of you these income sources and give you a brief description and hopefully you can understand how you earn your money better. Personal finance is hard to figure out for many people, but this post will get you one step closer to understanding how one income source favors the other.
Brief Descriptions of each Source:
Earned – Income derived from working for someone else or from a business you own or are a part of. This type of income is taxed the highest out of all the other incomes. It is also the biggest chunk of tax the government makes off individuals for GDP Revenue. In certain situations this type of income can be taxed at and up to 50% of the gross amount you make. The reason being that in this income type you have to pay Social security and medicare taxes.
Portfolio – Income derived from investments including dividends, interest, royalties, and capital gains. When you put your money in a savings account and the bank pays you for having it there that is considered portfolio income. If you write a book, then the royalties of the book sales are considered portfolio income. The tax implications from these types of incomes can be confusing, but dividends and capital gains taxes usually are up to a max of 20% and royalties can be taxed like self-employment ordinary income.
Passive – Income made of work in which you do not actively participate in. Examples include Rental real estate and silent business arraignments. This type of income is what people call gravy because you do not have to put your blood, sweat, and tears into it. Building a rental real estate empire is considered passive income for tax purposes, but believe me when I tell you managing something like a rental empire does take a lot of participation unless you hire a management company and reduce your time commitment.
In the United States people make the mistake to think that income from dividends are considered passive income and this is a mistake, the IRS clearly defines that type of income as portfolio. In my opinion I believe it is mandatory to try to build income from all three sources and then to begin to eliminate earned income and focus on growing the portfolio and passive income sources. If you can eventually grow your portfolio and passive income to cover all expenses then you are finally considered financially free.
Comment to let me know what are your thoughts to the three types of income sources listed above.
Always consult with a tax professional if you have a tax related question or if you are receiving income from different sources as mentioned above. If your taxes are complicated always consult with a certified CPA professional.