4 mins
May 20, 2022

Passive vs. Earned Income in Tax Efficient Investing

Passive vs. Earned Income in Tax Efficient Investing

Is generating passive income the best way to build wealth?

It’s not surprising that “passive income” has become one of the biggest buzzwords for marketing to investors. The thought of earning money passively, without putting in extra work, is incredibly appealing. 

But is passive income generation really the best way for Accredited Investors to build wealth? The answer is complicated, and it requires investors to shift their perspective from only focusing on returns to also considering options that could reduce their taxes. 

After all, as an Accredited Investor, you’re naturally going to fall into some of the highest tax brackets, meaning you won’t ever see 35+% of the income you’ve worked hard for all year. Wouldn’t it be nice if there was an investment option that allowed you to not only generate returns but also hold onto more of your earned income?

Well, now there is. But first, we’re going to break it down so you can understand all of your options.

Understanding Passive vs. Active Income

The IRS technically separates income into three “buckets” or categories: passive income, earned (or active) income, and portfolio income. For the purpose of this article, we’ll be focusing on passive and active income; essentially, income you earn through a job versus income you earn through investing. 

Diagram of 2 buckets labeled "Active Income: W2 Income" and "Passive Income: Real Estate, Royalties, etc."

Active income, which includes any money you earn from a W-2 job, contract work, or self-employment, is taxed at the highest rate of any type of income. So not only are you working harder to make more money, but you’re then required to give more of that money away to the government.

This explains why passive income is so appealing to investors. Income from rental real estate is usually taxed at passive income rates, and owners can also apply depreciation. 

The Two Bucket Theory and Taxes

The problem with the way passive and active income are divided is that the two buckets don’t usually mix. Even if you use your active, earned income for passive income generating investments, those investments typically cannot reduce your earned income. 

So while passive income is a powerful way to grow your wealth without working more hours, the more you earn, the more you’ll have to pay in taxes. And at the same time, your earned income will still be taxed at the highest rate, we’re usually talking about 35% or more for Accredited Investors! 

Reduce Your Taxable Earned Income with Direct Investments

Fortunately for Accredited Investors, there is a new way to reduce your taxes by decreasing the amount of earned income that’s eligible to be taxed. 

The government is looking for ways to incentivize cleaner energy generation, and so they’re offering major tax advantages to Accredited Investors who are contributing to those efforts. In particular, when you invest in equipment that is related to the Carbon Capture process, up to 100% of your investment can be deductible against your earned income in the first year. 

This provides a rare opportunity for high net worth individuals looking to reduce their taxable income while generating passive income from the same investment. 

The Power of Earned Income Tax Benefits

Let’s use an example. If you were to take some of your W-2 earnings and invest them in a new rental property, you would still pay around 35% in taxes on that W-2 income. You’d also pay taxes on any passive income you make from renting out the house.

If, however, you invested that same money into Carbon Capture initiatives, the amount you invest would be eligible to be deducted from your earned income. So not only will you get consistent returns on your investment, but you’ll also pay less in taxes on the money you invested because of current Bonus Depreciation Rules. 

This sets our Carbon Capture investment opportunity for Accredited Investors apart from any passive income generating investment, because it not only helps you make more money, but it also helps you keep more of the money you’ve already earned.

White and Orange Text on Blue Background: “This Investment Will Cut Your Next Tax Bill Dramatically (It’s not real estate!). Download Now.

Now is the Time to Plan for 2022 Taxes

At First Generation Capital Partners, we’re committed to helping our clients earn money through tax efficient, direct investments, because we believe that building wealth is less about working harder and more about investing smarter. 

To date, FGCP has invested more than $3 million in Carbon Capture Units and proprietary technologies, and we plan to invest even more in 2022. We’ve seen incredible results for our clients so far, and if you’re looking to reap the full tax benefits for this year, now is the time to invest. 

If you’re interested in learning more about this investment opportunity and its tax advantages, we would be happy to connect with you. Please fill out this brief form so we can start to understand your investment needs, and we will get in touch with next steps. 

May 20, 2022
Billy Keels