Nonpassive Income and Losses

Nonpassive income and losses constitutes any income or losses that cannot be classified as passive. Nonpassive income includes any type of active income, such as wages, business income or investment income. Nonpassive losses include losses incurred in the active management of a business. Nonpassive income and losses are usually declarable and deductible in the year incurred.

Nonpassive income and losses cannot be offset with passive losses or income. For example, wages or self-employment income cannot be offset by losses from partnerships or other passive activities. Conversely, nonpassive losses cannot be offset by passive income from partnerships or other sources of income in which the taxpayer is not a material participant.

Activities that include the taxpayer’s material participation in the effort that result in losses or income may be classified as nonpassive. According to the Internal Revenue Service, the tests for nonpassive versus passive are rooted in time spent and actions performed in the pursuit of the revenue. The losses or income may qualify as nonpassive if the taxpayer annually and actively participates for more than 500 hours in the business venture. That requirement falls to 100 hours if no other partner or co-worker puts in more work hours towards the venture than the tax payer during the year.

This does not include, however, serving as a manager of the business if there is another manager fulfilling those same duties. Furthermore, owning a business yet putting in work hours only for the sake of claiming material participation might not meet the criteria of the IRS for nonpassive.

There are other types of income that can qualify as nonpassive. Income derived from investment portfolios can receive this classification. That can include dividends, proceeds of the sale of investments, and interest. Compensation paid for the destruction or theft of property is considered nonpassive.

Sources of retirement income such as deferred compensation and social security may also be included as nonpassive. Just as income from these sources must be reported, any losses associated with these activities can be deducted from the taxpayer’s taxes. This also includes general partnerships that have the responsibility to oversee the day-to-day operations of a business. Nonpassive losses that general partners face may, in turn, affect the business they are managing, as they may attempt to sell or its assets to address their own personal losses. This could, in turn, lead to the closure of the business.