Active Income
Active income is income earned through direct participation in a trade, business, or employment, including wages, salaries, tips, commissions, and income from businesses in which the taxpayer materially participates. It is distinguished from passive income and portfolio income under the IRS passive activity rules and is subject to self-employment tax when earned through self-employment.
Under the IRS framework established by the passive activity rules of the Tax Reform Act of 1986, all income is classified into one of three buckets: active (or earned) income, passive income, and portfolio income. Active income is the most straightforward category — it is income a taxpayer receives in exchange for direct personal labor or from a business in which they materially participate.
For employees, active income includes wages and salaries reported on Form W-2, as well as tips, bonuses, commissions, and severance pay. For self-employed individuals, active income includes net profit from a sole proprietorship (reported on Schedule C of Form 1040) and income from partnerships or S corporations in which the taxpayer materially participates. Active income from self-employment is subject to self-employment (SE) tax — a 15.3% levy on net self-employment income up to $176,100 (2025 Social Security wage base), and 2.9% above that threshold, with an additional 0.9% Medicare surtax on earnings above $200,000 ($250,000 married filing jointly).
The distinction between active and passive income has important tax consequences. Active income can be offset by business losses from activities in which the taxpayer materially participates (subject to the at-risk rules of Section 465 and the basis limitation rules for partnerships and S corporations). Active income generally cannot be reduced by passive activity losses.
For investors who also operate businesses, the classification of their business income as active or passive determines whether the Section 199A qualified business income (QBI) deduction applies. The QBI deduction, which allows eligible taxpayers to deduct up to 20% of qualified business income from pass-through entities, applies to active business income from qualified trades or businesses — not to passive investment income like dividends, interest, or capital gains, and not to income from certain specified service trades or businesses (SSTBs) above applicable income thresholds.
Active income is not subject to the 3.8% Net Investment Income Tax (NIIT), which applies to passive income and portfolio income. However, wages above $200,000 ($250,000 married filing jointly) are subject to the 0.9% Additional Medicare Tax.
For investors transitioning from employment to self-employment or business ownership, understanding the active income classification is crucial for estimating quarterly estimated tax payments and planning for SE tax liabilities that do not apply to W-2 employment income.