Passive Activity

Lying on the couch with a bag of Cheetos and watching reality shows: it’s our favorite passive activity. No physical exertion required. But if we were to ask our tax preparer how this affects our taxes, she’d tell us that that’s not really what the IRS means by “passive activity.”

According to the IRS, a “passive activity” is one that earns or loses us money, but that we don’t have any active involvement in.

So if we’re a landlord, for example, our rental income is considered a passive activity. Or if we’re the “limited” part of a limited partnership, our income from the partnership is considered passive income. (But be careful here, because if we work for that company for more than 500 hours in a given year, it might be tough to prove that our participation isn’t material instead of passive.) Why does this matter? Because passive activities are taxed differently. If we’ve got passive losses, we can deduct the amount from our passive income (like dividends), and that can significantly decrease what we owe come April. And we all know what that means: more money for Cheetos.