Active vs. Passive Income: Why It Matters More Than You Think in Tax Planning

When it comes to tax planning, most high earners focus on how much they make, but few realize that what kind of income they earn can make or break their tax strategy.

Understanding how the IRS classifies your income is one of the most important, and most overlooked, factors in reducing your tax bill. At Revo Tax, we help clients leverage these classifications to create personalized strategies that work with the tax code, not against it.

The 3 Buckets of Income

The IRS organizes your income into three distinct buckets, each with different rules and planning implications:

1. Active Income

This includes wages (W-2), self-employment income, and even income from pensions or 401(k) withdrawals. It’s considered “earned” income and is often taxed at the highest rates.

“If you're a high W-2 earner, you can't just go buy into a passive real estate deal and think you're going to write it all off.” – Kevin

2. Passive Income

This comes from real estate, rental properties, or business partnerships where you’re not materially involved. The appeal is obvious, ongoing income without day-to-day work, but the IRS sets strict limits on how passive losses can be applied.

“Imagine you're Mark Cuban buying into a business on Shark Tank—that income is generally passive unless you're actively running the show.”

3. Portfolio Income

This includes capital gains, dividends, and interest. While it benefits from long-term holding incentives, it also comes with a $3,000 cap on deductible capital losses against ordinary income. Beyond that, losses must be carried forward year after year.  

Tax Strategy Tip, sometimes portfolio deductions can be converted into active or passive deductions, but it takes the right fact sets, or at least the right planning to change the fact sets.)

Why Your Income Bucket Matters for Tax Strategy

Here’s where many high-income earners go wrong: they assume any tax deduction can offset any kind of income.

But that’s not how the system works.

• Passive losses cannot offset active income (unless specific qualifications are met).
  
  
• Portfolio losses are limited, and mostly irrelevant to reducing taxes on earned income.
  
  

That’s why one of the most powerful tools in tax planning is generating active tax losses. Active losses can offset all three types of income: active, passive, and portfolio, making them incredibly valuable.

But to do this effectively, you first need a diagnosis.

The Power of a Baseline Scenario

At Revo, we start with a baseline scenario: a snapshot of what your taxes will look like if you do nothing. From there, we categorize your income into the three buckets and design strategies to address the areas with the most opportunity.

This isn't theory, it’s math and law, applied with precision.

Real Tax Strategies That Work

Here are a few examples we’ve used with clients to drive meaningful tax reductions:

Crypto Loss Harvesting

Because crypto doesn’t fall under the same wash-sale rules as stocks, you can sell at a loss and immediately repurchase, giving you a capital loss to offset gains, without changing your long-term investment.

Oil & Gas Investments (Working Interest)

When structured properly, working interest investments in oil and gas can create massive active losses even for investors who are otherwise passive. Add general partner liability and insurance, and it becomes one of the most powerful year-end tools available.

Charitable Asset Donations

Donate appreciated property (rather than cash), and you may receive a deduction based on fair market value, not what you paid, while avoiding capital gains. There are other charitable options that with proper documentation and valuation, this strategy can provide a 4–5x deduction multiple, but be careful as there are a lot of unscrupulous companies offering such ideas that won’t hold up to the IRS..

 Spousal Strategy

If your spouse is underemployed or has extra time, structuring a legitimate side business can open the door to equipment deductions, bonus depreciation, and additional active losses, all while aligning with your long-term financial goals.

Know Your Bucket. Then Build a Plan.

As we like to say:

Change your facts, and you can change your tax.

Income type matters. So does timing. The sooner you understand what you're working with, and what’s possible, the more strategic your tax position becomes.

Ready to Rethink Your Tax Plan?

If you're earning high income but still relying on a tax preparer who simply files your return, you’re missing out on major opportunities. At Revo Tax, we specialize in a forward-thinking tax strategy that’s built for real people, real income, and real savings.

Let’s build your plan together.

Schedule Your Free Consultation Today

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