You work hard for your money. But did you know not all income is taxed the same way? If you’re running a business, investing in real estate, or stacking multiple income streams, understanding how the IRS classifies your income can be the difference between keeping more of your cash or overpaying in taxes every year.
Many high earners assume that income is income but nope, the IRS doesn’t see it that way. The tax code treats passive and active income very differently, and if you don’t know the rules, you could be missing out on big tax savings.
At Insogna CPA, one of the top CPA firms in Austin, Texas, we help business owners and investors structure their income in a way that legally minimizes taxes and maximizes deductions. Let’s break it all down—in plain English—so you can make smarter financial moves.
Passive vs. Active Income: What’s the Difference?
Your income falls into two main categories:
1. Active Income (a.k.a. Earned Income)
This is money you actively work for—the kind that requires your time and effort. This includes:
- W-2 wages from your job
- Self-employment income (freelancing, consulting, running a business)
- Side hustle income (Etsy shop, online courses, Uber driving)
Tax impact: Active income is taxed at ordinary income tax rates (up to 37% for high earners) and, if you’re self-employed, you also get hit with self-employment taxes. Basically, this is the most expensive type of income tax-wise.
2. Passive Income
Passive income is money you make without actively working for it (or at least, not daily). The IRS defines passive income as coming from:
- Rental properties (unless you qualify as a real estate professional)
- Limited partnerships
- Businesses you own but don’t actively manage
Tax impact: Passive income is usually taxed at lower rates, and in some cases, you can use passive losses to offset passive income, reducing your tax bill.
Sounds great, right? But here’s where things get tricky: passive losses don’t always offset active income.
Wait… My Rental Property Losses Can’t Reduce My W-2 Taxes?
If you own rental properties and report a $20,000 real estate loss on paper (thanks to depreciation, mortgage interest, and expenses), you’d think you could use that loss to lower your taxable income from your job.
Problem: The IRS doesn’t work like that. Rental real estate losses are considered passive losses, while your salary is active income and the two don’t mix.
Solution: The key is knowing how to qualify as a real estate professional or using short-term rental strategies to unlock bigger tax savings. That’s where a solid Austin tax accountant can help.
How to Pay Less in Taxes (Legally, of Course)
Now that you know not all income is taxed the same, here’s how to use that knowledge to pay less and keep more.
1. Become a Real Estate Professional
If you or your spouse qualify as a real estate professional, you can use real estate losses to offset your W-2 or business income. To qualify, you need to:
- Spend 750+ hours per year in real estate activities.
- Have more than 50% of your working hours in real estate.
For real estate investors with high earnings, this can be a massive tax savings strategy. A small business CPA in Austin can help make sure you meet IRS rules.
2. Use the Short-Term Rental Loophole
If you own Airbnb or vacation rentals, you might be able to use rental losses to offset active income without needing real estate professional status.
The key? Actively managing your short-term rentals and meeting the IRS’s guidelines.
Pro Tip: Work with an Austin small business accountant to structure this correctly and avoid IRS red flags.
3. Offset Passive Income with Passive Losses
If you’re stuck with passive losses you can’t use, invest in other passive income streams (like partnerships or REITs) to balance things out.
Why it works: Passive income can cancel out passive losses, helping you lower your overall tax bill.
Smart move: A tax advisor in Austin can help structure your investments to take advantage of this strategy.
Let’s Structure Your Income the Right Way
Knowing how passive and active income are taxed isn’t just helpful—it’s a game-changer if you want to keep more of your money. Whether you’re an investor, business owner, or high-income professional, structuring your income the right way can mean thousands in tax savings.
At Insogna CPA, we specialize in tax strategies that help business owners, real estate investors, and high earners legally pay less. Whether you need guidance from a CPA in Austin, Texas, or want a proactive tax plan from a small business CPA in Austin, we’ve got you covered.
Want to pay less in taxes? Let’s structure your income the smart way. Contact Insogna CPA today...