Definition
Active income refers to income received for performing a service or running an active business. It includes wages, salaries, tips, and profits from businesses in which the individual is directly involved. Essentially, it’s any income that requires active work for its generation.
Key Takeaways
- Active Income refers to income received for performing a service. It includes wages, tips, salaries, commissions, and income from businesses in which there is substantial daily effort.
- The individual is actively involved in the activities that generate this income. For instance, a person working a 9 to 5 job, a small business owner taking care of daily operations, or a freelance worker being paid for their skills.
- In terms of taxation, active income is generally subject to federal, state, and social security taxes, making it different from passive income where tax rules may vary.
Importance
Active income is an important finance term because it refers to income generated from directly participating in an activity or providing a service.
This could be derived from wages, tips, salaries, commissions, and income from businesses in which there is material participation.
Understanding active income is crucial because it affects income tax calculations, as these earnings are subject to Social Security and Medicare taxes, amongst others.
In comparison to passive income where you earn without active participation, active income requires continuous efforts.
This distinction is vital for individuals and businesses for strategic financial planning, deciding work-life balance, and long-term investment choices.
Explanation
Active income refers to income that is earned through direct involvement in a business venture or employment. It’s primarily received from a job where one works for wages or salary, therefore, it demands participation or services from the recipient.
Active income also includes any profits made from operating a small business or any venture where an individual is directly involved. It symbolizes the financial reward that you receive for your time and effort.
The primary purpose of active income is to provide a regular source of income for individuals, which can be used to cover their day-to-day expenses. This type of income is primarily used for buying commodities, paying bills, servicing loans, saving for future needs, investing for further income generation, or improving one’s standard of living.
Since active income demands an individual’s time, knowledge, or skills, it often becomes a primary determinant of their economic status. It plays an essential role in supporting the individual’s livelihood and fulfilling monetary obligations.
Examples of Active Income
Employment Income: The most common example of active income is the paycheck you receive from your job. This is money that you earn by physically working, whether that’s a standard 9-to-5 job, part-time work, or freelancing. This requires active participation, thus it is termed as active income.
Small Business Income: If you own and operate a business, the profit you receive from the daily operations of the business is considered active income. This includes any type of business – from a brick-and-mortar store to an e-commerce website. Your active involvement in managing the business, making decisions, and providing services mean this income is categorized as active.
Commission Based Income: A person working in a job or business and earning on a commission basis is another example of active income. Real estate agents, car salespeople, and insurance salespeople often work primarily for commissions. They actively work to sell products or services, and their income fluctuates based on their success in doing so.
FAQs About Active Income
What is Active Income?
Active income is the income for which services have been performed. This includes wages, tips, salaries, commissions, and income from businesses in which there is material participation.
What is an example of Active Income?
Examples of active income include wages, salaries, bonuses, commissions, tips, and net income from a business in which the taxpayer materially participates. For example, an accountant who works for a monthly salary is earning active income.
How is Active Income taxed?
Active income is subject to full federal income taxes at both the personal and corporate level. The tax owed on active income depends on the individual’s tax bracket, which can range from 10% to 37%.
What is the difference between Active and Passive Income?
Active income involves earning money in exchange for a service. It could be wages from a job or profits from a business you actively manage. On the other hand, passive income involves earning money from ventures in which you’re not actively involved, such as rental income or dividends from an investment.
Can I have both Active and Passive Income?
Yes, it is possible to earn both active and passive income. Many people diversify their income streams and have a blend of active income (from a job or business they actively manage) and passive income (such as real estate investments or royalties from a book).
Related Entrepreneurship Terms
- Passive Income
- Earned Income
- Portfolio Income
- Income Generation
- Investment Income
Sources for More Information
- Investopedia – This website provides a whole section on personal finance including active income.
- The Balance – It is a well-known and reliable source that covers all finance-related concepts, including active income.
- The Motley Fool – This site offers in-depth investment advice and explanations of finance concepts such as active income.
- Financial Express – It offers news related to finance and economics and covers topics like active income.
