Active Income | Definition

Active income is earned directly from your work. Examples include wages, salaries, commissions, fees, and tips.

Income is any money coming into a household, but according to the Internal Revenue Service (IRS), not all income is created equal. Some classic examples are self-employed vs. employee income, long-term vs. short-term capital gains, and active vs. passive income.

Active income is money received for work you do directly. If you are actively participating in generating your income, that is active income.

Active Income vs. Passive Income

The IRS distinguishes between active and passive income in how it is taxed, so it is important to know the difference. Active income will always be taxed according to your tax bracket. Most active income is also subject to the payroll tax for Medicaid and Social Security. When it comes to active income, there is very little you can do to avoid being taxed on it. You can contribute to retirement through a traditional 401k or IRA, and there is the standard deduction, but other than that, you will pay taxes on active income.

Passive income is money that you don’t work for. Examples of this include rent, royalties, interest, and dividends. While passive income is taxed at the same tax bracket as your active income, it is not subject to payroll taxes. The more you receive passive income instead of active income, the less you will pay in overall taxes, generally speaking.

What is Considered Active Income?

The majority of an average person’s income is in the form of active income. If you are working a job, you are earning active income. Active income mostly falls into these categories: 

Wages

Wages are money earned usually on an hourly basis. When you are directly compensated for how much time you put into a job, you are earning wages. This can range from minimum wage fast food workers to lawyers who bill by the hour.

Salary

Salary is when you are paid a fixed amount per pay period regardless of the number of hours that goes into a job. Examples of this are teachers and most corporate jobs.

Tips

Tips are money received as a bonus for services rendered. It is often paid in cash. Tips should be subject to payroll taxes, but they are chronically underreported since it is usually an all-cash transaction. Classic examples of tip earners are servers and bellhops.

Commission

Commission is money received as a percentage of a sale made. Instead of being compensated for hours or at a fixed rate, this is a model of compensation based entirely on performance. Realtors and salespeople are examples of commission earners.

Fees

Fees are money received for services rendered. This is when someone charges a fixed rate for performing a job regardless of the amount of time it takes. A hairdresser is a fee-based business because they charge per cut and not per hour.

Recommended Read: How to Recession Proof Your Finances

The Money Wrap-Up: Benefits of Having an Active Income

Active income has one primary benefit. Unlike passive income, active income can be used to contribute to a retirement plan such as a 401k or an IRA. This allows you to reduce your tax burden (now or in the future) and put aside money for retirement in a tax shelter. Active income is also the only way to contribute to social security. Active income, then, is a great vehicle for retirement contributions.