If you don’t want to work forever, you might want to look for ways to generate passive income — money you get without toiling. Much of the income you earn from passive sources is taxed at preferential rates. Translation: You keep more of it.
Generating passive income usually does require assets. But you may already own them.
A number of online platforms have formed to help people generate passive income by renting out possessions they already have. These possessions can range from big things such as whole houses and cars to smaller ones that you may never have considered particularly valuable, such as your driveway, attic space, carpet cleaner or tools. Some platforms enable artists to earn royalties and licensing fees for the use of their art.
When you earn income from work in the United States, you’re subject to a host of taxes, such as state and federal income taxes, as well as employment taxes that fund systems such as Social Security and Medicare. Passive income is taxed differently and, generally, less heavily.
Some forms of passive income are not taxed at all. If you, for instance, earn thousands of dollars renting out your personal residence for up to 14 days a year, that income is tax free. (Beware, though: If you rent out your home for even one more day, all that otherwise tax-free income gets thrown into the taxable column.)
Most other forms of passive income are taxable. But unless you turn your passive income into a part-time business, you’ll at least avoid employment taxes on the revenue, says Mark Luscombe, principal federal tax analyst with Wolters Kluwer.
Even when income from mostly passive activities — like renting out your personal possessions — is classified as self-employment income, you can qualify for tax breaks that are likely to drastically cut Uncle Sam’s take. Specifically, self-employed individuals can deduct all the expenses required to earn this income before determining the taxable portion of the revenue. There’s also a special 20% deduction that further reduces the taxable portion of self-employment income, Luscombe says. But you should seek professional tax guidance to determine which rules affect which forms of your revenue. The U.S. tax code is complex and full of land mines.
The most common way to earn passive income is to invest in dividend-paying stocks. In most cases, the dividends on long-held investments are considered “qualified,” which means they would be subject to a maximum tax rate of 20%. (That compares with the top tax rate of 37% for earned income, which is also subject to FICA tax.)
But dividend income is rarely generous. …….