A passive entity is generally a business or investment entity whose income comes primarily from passive sources, such as investments, royalties, or certain partnership interests rather than active business operations.
Determining whether an entity is passive can affect how income, losses, and deductions are treated under the passive activity rules.
What Types of Entities Can Qualify as Passive Entities?
To be considered a passive entity, the organization must generally be one of the following:
- A general partnership
- A limited partnership
- A limited liability partnership (LLP)
- A trust (excluding business trusts)
In addition, the entity must meet certain income requirements.
What Income Qualifies an Entity as Passive?
At least 90% of the entity's federal gross income for the tax period must come from qualifying passive income sources.
Investment Income
Qualifying income includes:
- Dividends
- Interest
- Foreign currency exchange gains
- Payments related to notional principal contracts
- Option premiums
- Cash settlement or termination payments related to financial instruments
- Income received from a limited liability company (LLC)
Partnership Income
The entity may also receive:
- Distributive shares of partnership income, to the extent those amounts are greater than zero
Capital Gains
Qualifying income includes:
- Net capital gains from the sale of real property
- Net gains from the sale of commodities traded on a commodities exchange
- Net gains from the sale of securities
Mineral and Royalty Income
Qualifying income may also include:
- Royalties from mineral properties
- Mineral property bonuses
- Delay rental income from mineral properties
- Income from non-operating mineral interests
These income sources are generally considered passive because they are derived from investments rather than active participation in a trade or business.
Why Does Passive Entity Classification Matter?
Passive activity rules can affect:
- Whether losses are currently deductible
- How income and losses are reported
- The ability to offset passive income with passive losses
- Certain state tax filing requirements
Understanding whether income is passive or nonpassive is an important step when preparing your tax return, especially if you receive income from partnerships, LLCs, trusts, or other investment entities.
How Do I Enter Information From a Passive Entity?
Income, losses, deductions, and credits from passive entities are commonly reported to investors on a Schedule K-1.
The information from your Schedule K-1 is then transferred to the appropriate areas of your tax return, including Schedule E when applicable.
How Do I Complete Page 2 of Schedule E?
Page 2 of Schedule E (Form 1040) is used to report income, losses, and deductions from pass-through entities, such as:
- Partnerships
- S corporations
- Estates
- Trusts
If you received a Schedule K-1, enter the information from the form into the corresponding K-1 section of the program, using the following pathway:
- Federal
- Income - Select my forms
- Less Common Income
- K-1 Earnings
Our software will use the information you enter to populate the appropriate lines on Schedule E and other related forms when required.
Where Do I Enter My Schedule K-1 Information?
To report information from a Schedule K-1, navigate to the appropriate K-1 entry section within the program and enter the amounts exactly as shown on your form.
For detailed instructions, see our support articles covering:
- Schedule K-1 (Form 1065) for Partnerships
- Schedule K-1 (Form 1120-S) for S Corporations
- Schedule K-1 (Form 1041) for Estates and Trusts
These guides provide step-by-step instructions for entering K-1 information and understanding how it affects your return.
Important
Being associated with a passive entity does not automatically mean all income or losses are passive. The tax treatment can depend on factors such as:
- Your ownership interest
- Whether you materially participated in the activity
- The type of income reported
- Special passive activity loss rules
If you're unsure whether your activity is passive or nonpassive, review your Schedule K-1 carefully and keep records that support your level of participation.