when an individual is an owner of an interest in a partnership or s corporation they re issued a schedule k 1 that individual has to determine whether their stake is passive or nonpassive 
the irs and nonpassive activitythe irs defines passive income specifically for tax purposes distinguishing it from general usage true passive income activities include trade or business activities where the taxpayer does not materially participate and rental activities unless the taxpayer is a real estate professional 1to determine whether an income is passive or nonpassive you usually need to determine material participation the irs provides seven tests to define material participation such as participating in an activity for more than 500 hours a year or having substantial involvement in the business meeting any of these tests means the income is nonpassive and should be reported accordingly to the irs almost all real estate activities are generally considered passive unless the taxpayer qualifies as a real estate professional by meeting specific participation requirements temporary rentals like airbnb may be classified differently based on the services provided and rental duration 1for tax purposes spouses participation counts toward material participation and passive losses can only offset passive income with excess losses carried forward to future years passive income is typically taxed at the individual s marginal tax rate we ll also talk more about passive loss treatment later in this article reporting nonpassive income on tax returnsnonpassive income and losses are reported on your tax return depending on the source of the income if you re a business owner or self employed nonpassive income and losses are typically reported on schedule c profit or loss from business this form details your business income and expenses wages salaries and other forms of employment income are reported on form w 2 which your employer provides at the end of the year this form shows the total amount of nonpassive income earned as well as taxes withheld social security contributions and other relevant information if you have multiple sources of nonpassive income you can combine these amounts when calculating your total taxable income nonpassive losses are reported similarly and can offset nonpassive income reducing your taxable income for instance if your business has more expenses than it earns in revenue you d have a net loss this loss can be deducted from your other nonpassive income passive activity losses and tax treatmentthough this article is about nonpassive income it s important to highlight passive activity losses this is the crux of why it is important at least for tax reasons to be able to distinguish between passive and nonpassive activity the irs generally restricts the use of passive activity losses pals to offset only passive income this means that losses from passive activities cannot be used to reduce nonpassive income such as wages salaries or income what we listed above in this article if passive losses exceed passive income in a given year the excess losses cannot be deducted from nonpassive income instead these excess losses are carried forward to future tax years where they can be used to offset future passive income 