Close this search box.

Table of Contents

Nonpassive Income and Losses


Nonpassive income and losses refer to earnings and deductions derived from active participation in a trade or business. This typically includes wages, salaries, commissions, and income from businesses in which the taxpayer materially participates. Nonpassive losses can be used to offset nonpassive income, reducing the overall taxable income.


Nonpassive Income and Losses: Nonpassive – /nɒnˈpæsɪv/Income – /ˈɪnˌkʌm/and – /ænd/Losses – /ˈlɔː.sɪz/

Key Takeaways

  1. Nonpassive Income and Losses: Nonpassive income and losses refers to earnings or deficits from business activities in which a taxpayer materially participates. This includes salaries, wages, tips, and income from active business partnerships.
  2. Tax Implications: Nonpassive income can have significant tax implications as it is generally subject to the Federal Income Tax. Passive losses may be used to offset nonpassive income, however nonpassive losses cannot offset passive income.
  3. Material Participation Test: The IRS applies a “material participation test” to ascertain if an individual is actively involved in an income-generating activity. If they pass this test, their profits and losses are classified as nonpassive.


Nonpassive Income and Losses is an important term in business/finance as it refers to income or losses stemming from active participation in a business. This differs from passive income which comes from ventures in which an individual is not actively involved. Nonpassive income typically includes salaries, wages, tips, commissions, and income from businesses in which there is material participation. Understanding the difference between nonpassive and passive income is crucial as it can affect taxation. Certain losses from nonpassive business activity can be used to offset nonpassive income, potentially reducing the amount of taxable income, which is a significant aspect of financial planning and management.


Nonpassive income and losses are widely used in finance, particularly in relation to taxation of income derived from business activities. Essentially, this type of income is earned from labor-intensive tasks, salaried work, or a business where the taxpayer substantially participates in its operations during the tax year. The primary purpose of categorizing income in this manner is to distinguish between the income generated via direct, active participation and passive income sources, such as rental activity or business situations in which an individual is not materially involved.Nonpassive income and losses are significant when calculating an individual’s tax liability because certain rules, benefits, and deductions apply specifically to this category. For example, nonpassive losses, in contrast with passive losses, can often be fully deducted in the year they occur. However, it’s crucial to note that nonpassive income is subject to Self-Employment tax where passive income is not. Understanding the difference between these types of income is vital for proper tax planning and can significantly impact an individual’s or business’s net taxable income.


1. Self-Employment Income: Consider a professional freelancer like a graphic designer who is running their own business. They are actively involved in managing the business – searching for clients, completing design projects, invoicing clients, and maintaining the business. The income they earn is considered nonpassive because it is derived from an activity where the owner materially participates.2. Salary or Wages: For instance, an individual who is gainfully employed by a corporation and receives a fixed salary for their work. They are actively involved in the company’s operations and the tasks they perform are crucial to the profitability of the business. This is an example of nonpassive income, as the employee is directly involved in earning the income they receive.3. Retail Business Profits: Take for example, a person who owns and operates a clothing boutique. They participate actively in the business- buying the clothing, managing inventory, selling products, handling customer service, and overseeing the employees. The profits generated from the boutique are a form of nonpassive income, since the owner is materially involved in the operations of the business. The loss, if any, incurred by the business is also nonpassive, as it directly impacts the owner who is actively participating in the business operations.

Frequently Asked Questions(FAQ)

What is nonpassive income and losses?

Nonpassive income and losses refer to the earned income from business activities or investments in which the taxpayer materially participates on a regular, continuous and substantial basis.

Can you give examples of nonpassive income?

Yes, nonpassive income typically includes wages, salaries, tips, commissions, interest income, and income from businesses in which one actively participates.

What are nonpassive losses?

Nonpassive losses are financial losses that originate from activities in which a person actively participates. These losses can often be deducted from your regular income (up to certain limits).

How does nonpassive income and losses affect my taxes?

Nonpassive income and losses are significant for taxation purposes because they influence your overall taxable income. Nonpassive losses can significantly lower your taxable income, thus reducing the amount of money you owe in taxes.

Can I use nonpassive losses to offset other income?

Yes, nonpassive losses can often be used to offset other types of income (with certain restrictions and limitations), which can include wage, salaries, interest and dividend income.

What is the difference between passive and nonpassive income and losses?

The key difference lies in your level of involvement in the activity generating income or losses. Nonpassive income and losses originate from activities in which you actively participate, whereas passive income and losses come from activities where you’re not a material participant.

How do I know if my income is passive or nonpassive?

Your income is likely nonpassive if you’re engaging in the activity on a regular, continuous, and substantial basis. Frequent decision-making or daily involvement suggests nonpassive income. Otherwise, it’s likely passive. It is always recommended to consult with a tax professional for an accurate assessment.

Related Finance Terms

Sources for More Information

About Our Editorial Process

At Due, we are dedicated to providing simple money and retirement advice that can make a big impact in your life. Our team closely follows market shifts and deeply understands how to build REAL wealth. All of our articles undergo thorough editing and review by financial experts, ensuring you get reliable and credible money advice.

We partner with leading publications, such as Nasdaq, The Globe and Mail, Entrepreneur, and more, to provide insights on retirement, current markets, and more.

We also host a financial glossary of over 7000 money/investing terms to help you learn more about how to take control of your finances.

View our editorial process

About Our Journalists

Our journalists are not just trusted, certified financial advisers. They are experienced and leading influencers in the financial realm, trusted by millions to provide advice about money. We handpick the best of the best, so you get advice from real experts. Our goal is to educate and inform, NOT to be a ‘stock-picker’ or ‘market-caller.’ 

Why listen to what we have to say?

While Due does not know how to predict the market in the short-term, our team of experts DOES know how you can make smart financial decisions to plan for retirement in the long-term.

View our expert review board

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More