Is portfolio income considered non-passive income?

Portfolio Income and Tax Classification

Portfolio income typically includes earnings such as interest, dividends, capital gains, and royalties. For tax purposes, it's important to distinguish between passive and non-passive income, as they are treated differently.

Non-Passive Income

- Non-passive income generally includes wages, salaries, tips, and business income from activities in which the taxpayer materially participates.

- Portfolio income is generally considered investment income rather than earned income from active participation in a business.

Passive Income

- Passive income is defined as earnings an individual derives from a rental property, limited partnership, or other enterprise in which they are not actively involved.

- According to the IRS, passive activities are those in which the taxpayer does not materially participate.

Net Investment Income Tax (NIIT)

- The [Net Investment Income Tax] (NIIT) applies to certain net investment income of individuals, estates, and trusts that have income above statutory threshold amounts.

- NIIT is set at a rate of 3.8% and includes categories of income such as interest, dividends, annuities, royalties, and rents, unless derived from a trade or business in which the NIIT does not apply.

- The NIIT specifically applies to income from a trade or business that is a passive activity or trading in financial instruments or commodities.

Classification of Portfolio Income for NIIT

- Portfolio income is generally considered investment income and can be subject to the NIIT if it falls under the categories of income that are included in the definition of net investment income.

- Portfolio income is not subject to self-employment taxes and is not generated from a trade or business in which the taxpayer materially participates, thus it is typically considered non-passive for the purposes of the NIIT.

Conclusion

Portfolio income is considered non-passive for tax purposes when it comes to the NIIT, as it falls under the category of investment income rather than active business income. It is subject to the NIIT if the individual's income exceeds the applicable thresholds. For more detailed information on the NIIT and its application to various types of income, refer to the [IRS's official guidance on the topic].

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Sources:

Questions and Answers on the Net Investment Income Tax 2024-08-03

Publication 925 (2023), Passive Activity and At-Risk Rules 2024-07-31

2023 Instructions for Form 8960 | Internal Revenue Service 2024-08-03

Topic no. 559, Net investment income tax | Internal Revenue Service 2024-08-04

Publication 550 (2023), Investment Income and Expenses | Internal Revenue Service 2024-08-02

Instructions for Form 1065 (2023) | Internal Revenue Service 2024-08-03

Instructions for Form 8582 (2023) | Internal Revenue Service 2024-08-02

Topic no. 425, Passive activities – Losses and credits 2024-08-02

Instructions for Form 1120-S (2023) | Internal Revenue Service 2024-08-03

Net Investment Income Tax | Internal Revenue Service 2024-08-02