Even during an excellent fiscal year, running a small business is no simple feat, as it often requires long hours and significant active effort to maintain. But if you don’t want to work for every dollar, it can be beneficial to set up passive income streams to supplement your profits. Taking advantage of the many passive income options is one way to find opportunity amid adversity. In fact, along with maintaining flexibility and leveraging existing resources, pivoting toward passive income streams was a common trait among businesses that survived and thrived in 2020.
To gain a better understanding of what passive income is, it’s important to first learn about the different types, gather some ideas to kickstart your own brainstorming, and select the right one for your small business.
What Is Passive Income?
Passive income is considered a “set it and forget it” revenue stream in which you sell products or services and earn money without being actively involved. This type of income is ideal for small business owners with limited staff and time who need to boost online sales.
For example, say the owner of an Etsy shop sells custom, handcrafted stuffed animals, but each sale requires a significant amount of work to make every net dollar. So to avoid being overworked, they create a PDF “printable” pattern in a few designs, set them at an enticing price, and market them on social media. The sales of the patterns could then keep rolling in continuously without the owner expending much effort. This can qualify as passive income.
Types of Passive Income
Residual Passive Income
Residual income is derived from assets you create or purchase that continue to profit with minimal upkeep after the initial work or investment. Examples and sources of residual income include commissions, renewals, return customers, rental properties, pre-recorded online course signups, e-book sales, and stock photography royalties. Residual income is taxed just like earned income. You pay taxes on yearly earnings based on your adjusted gross income (AGI) and federal tax bracket, plus state and local taxes, if they apply.
The terms “passive” and “residual” income are often used interchangeably, but they have different meanings.
Residual income can be passive in nature, but passive income isn't always residual. Passive income is money earned from business enterprises with little or no ongoing effort to maintain them. Residual income, however, is a measure of how much discretionary (nonmandatory) money is available from your income sources (earned or passive) after bills and taxes are paid.
Linear, or active income, which is what most people are used to, is when you do the work once, and you get paid once. For instance, think of it as someone working in an office eight hours a day, or 40 hours a week, and being paid one paycheck for that effort. Along with individuals, many businesses rely on linear income for most of their profits by creating products and getting one sale for each product in the process.
Leveraged income, though, is when you do work once and get paid many times afterward by leveraging other people’s work to create continual income for you. Here are some examples:
- A photographer takes photos and adds them to a stock photography website that markets their images while they sit back and collect royalties.
- An artist can sell in an online marketplace or ask a third party to fulfill their orders.
- A writer can sign with a publisher and let them handle sales and shipping of their books.
- A food blogger makes one recipe post, and through affiliate marketing and Pinterest traffic, earns profits that continue indefinitely.
Active Leveraged Income
Active leveraged income requires more participation than leveraged, but you can make more money at once by having other people involved. This type of income generally involves a one-time event, such as a live seminar or class, holding a virtual conference or convention, selling tickets for concerts, or holding fundraising events. Regardless of the passive income stream you choose, it’s essential to review the current passive income tax guidelines furnished by the Internal Revenue Service (IRS).
5 Ideas for Passive Income in 2021
The pandemic has caused a shift in consumer needs and spending habits, which of course has had a major effect on small businesses, from restaurants to retailers. Because of this behavioral shift, where people are opting for more contactless, digital forms of commerce, passive income should be considered for your business plan in order to adapt and increase your profit margin. Thankfully, there are many options to increase profits passively online.
Sell Your Expertise
During lockdown, people have been looking to take up new hobbies or for resources to grow their personal and professional skills. Your business can fill this need by actively leveraging online classes, live-streaming events, or Q&A sessions to reach more customers. Even if you’re not selling anything during these events, it’s marketing for your business that can endear and intrigue potential customers. Use platforms like Skillshare or Coursera to bring in sales from pre-recorded classes.
You can also share your knowledge through videos on YouTube and monetize it to create ongoing passive income for as long as the video is public.
Sell Your Knowledge
Package your knowledge digitally and set up an online delivery system for customers to automatically download content after purchasing. For example, you can sell e-books through Amazon Kindle Direct Publishing or sell digital printables on Etsy. If you’ve perfected a process or collected industry tips, create an e-guide. If you’re a writer, use regular online events like PitchWars to get your book draft in front of publishers. Locking in a book contract can mean more long-term book sales.
Rent Out Equipment
Renting can be a lucrative form of passive income, but don’t just think about renting your properties, extra office space, or storage areas. Consider renting equipment from your business as well. Just make sure you research the required licensing and permits for your specific city before setting this process up.
Rent Extra Space
Airbnb is a well-known passive income source for some homeowners. Businesses can consider using a platform to rent out storage space for passive income. You can even rent extra parking spaces (with your landlord’s permission, of course). Neighbor is one company that facilitates these kinds of exchanges. If you work from home or have a home-based small business, renting out extra space is an excellent way to reduce costs, as long as you report the income correctly on your taxes.
Outsource Business Steps
You can use another company’s services, otherwise known as outsourcing, to reduce the amount of time spent on each part of your production process. Letting someone else handle advertising, marketing, or fulfillment will save you time and maximize your profits. E-commerce channels like Shopify or Amazon may take convenience cuts. However, if you work that amount into listing prices, you won’t feel the loss. Those fees also qualify as necessary business expenses, so the IRS allows them to be claimed on taxes for Schedule C small businesses under “advertising” expenses.