Taxes are an inevitable part of life, and there is no doubt that it’s critical to comply with all legal obligations and ensure that you pay your taxes in whatever country you call home. Now, it doesn't matter if you are a contractor, salaried employee or run your own business – paying your taxes is your solemn responsibility.
With cryptocurrencies rapidly gaining traction and offering people additional opportunities to earn passive income, one question many people have is “do I need to pay tax on passive income?”
Taxation is a complicated subject, it’s important to consult with professional chartered accountants & chartered tax advisers like Hodge Bakshi. This article is not intended to provide professional advice – always talk to the experts about your individual situation.
Having said that, we will cover the basic concepts of passive income tax. However, before moving on, let's talk a little about what passive income is.
What Is Passive Income and How Does It Work?
Passive income is the earnings you make an activity without being actively involved in it, such as revenue from a rental property or any business activity where your contribution is minimal. In the most basic terms, it is the income obtained by exerting zero or minimal work.
Apart from the examples mentioned above, there are a number of other ways to generate passive income. If you have a savings account and your bank or financial institution pays you interest on the money in your account, then the extra money you are getting is passive income. Similarly, if your website contains ads and visitors click on them, your payment based on each click is the passive income.
The primary distinction between passive and active income is the way you earn the funds. You can generate passive money even if you are sleeping or spending time with your family on vacation. While you might need to make an investment to begin the passive income stream, once it is up and running, you generally don’t need to do much else.
Is Passive Income Subject To Taxation?
With so many individuals trying their luck to make passive money these days, there is quite a lot of confusion around whether you need to pay tax on this type of income. One common and unfortunate myth is that passive income is exempt from taxation.
However, the truth is, passive income is taxable, the same as active income. If you make money from an activity that does not require your participation but provides you with a monetary reward, you must pay tax on it. Furthermore, failing to properly disclose these earning as pay the appropriate amount of tax could get you into a load of trouble with the authorities and you could face steep fines and penalties.
What Is The Passive Income Tax Rate?
The tax rate on passive income is identical to the general tax rate in most countries. The rate at which you pay taxes on your active income is the same rate you must pay on your passive income.
Let's look at an example to understand this idea better. In the USA you may need to pay combined federal, state, and local taxes of 28%, depending on where you live. If a your total active income, for example as wages from your full time job, is $65,000, you’ll pay $18,200 in income tax.
Similarly:
-
- If you earn $65,000 in passive income, say from drop shipping or dividends on investments, you will still need to pay $18,200 in tax.
-
- If you earn $40,000 from a part time job and another $25,000 from passive income, so a total of $65,000, you’ll again need to pay $18,200 in tax.
To calculate your own tax obligations, you can use this calculator for US residents.
Rental income may be taxed differently than other types of passive income, as in many countries you can reduce the amount of tax you need to pay on rental income by adjusting for depreciation and amortization.
How To Report Passive Income
You can record your passive income using the standard self-assessment tax return form for your country of residence. In most countries, you can conveniently download and fill out these forms online. However, depending on the number of passive income sources you have, you might be required to fill out additional pages.
Filing your taxes can be confusing, especially when multiple income streams are involved. In such circumstances, it is critical to seek advice from a competent tax expert who can assist you with your tax return. It’s also better to contact a qualified tax adviser if you are filling out your tax return for the first time.
End Notes
When it comes to taxes on passive income, people frequently pay more than they should. If you’re not sure on how much tax you need to pay based on your passive income, it’s best to get professional advice from a certified chartered accountant or tax expert. They will walk you through the entire process, so you won't make any mistakes, fail to meet your obligations, or overpay on your taxes.
