Ordinary IncomeDefined with Examples & More

Lisa Borga

Ordinary income refers to any type of income for both businesses and individuals that are taxed at ordinary U.S. marginal tax rates.

Common examples of this type of income are wages, regular business income earned from regular operations, commissions, rents, tips, and nonqualified dividends, among other sources.

Notably, qualified dividends and long-term capital gains are not ordinary income and are instead taxed at a more favorable rate.

Ordinary Income Explained

ordinary income

Ordinary income is any type of income that is taxed at a regular U.S. income tax rate instead of another tax rate, such as those for long-term capital gains.

Ordinary income can include any type of income that is taxed at these standard rates, which are outlined by the Internal Revenue Service and updated regularly.

For individuals, their income tax rate is marginal, which means that the more money the taxpayer earns, the higher the tax rate will be and the more they will have to pay in taxes.

Ordinary income occurs when an individual or business earns money that is taxed at these ordinary income tax rates.

In 2022, the federal rates for single filers began at 10% of taxable income up to $10,275, raising progressively to the highest bracket of 37% for income greater than $539,900 for single filers.

These brackets are different based on the category of the taxpayer, such as single vs. joint filers.

For corporations, the income tax rate has been a flat 21% since the Tax Cuts and Jobs Act of 2017.

Prior to this, there were taxable income brackets, with the highest bracket rate reaching a far higher 35%.

This rate will apply to all of the corporation’s ordinary income and will need to be paid in addition to the tax paid on the income received by its owners (double taxation).

Practical Examples of Ordinary Income

The best way to understand how ordinary income works for both individual taxpayers and businesses is to see how it works in practice.

Here are a few examples to see how it works.

Individual Taxpayer

To understand how ordinary income works for an individual taxpayer, consider an IT professional who earns $2,500 per month.

Assuming that this taxpayer has no additional sources of income, then their ordinary income for the year will be $30,000 ($2,500 * 12).

If this worker had earned any additional income such as a bonus, tips from customers, or commissions, this would also generally be classified as ordinary income.

Similarly, if this taxpayer had chosen to rent out a room in their home, this would also typically be ordinary income.

However, for this worker, the $30,000 they earned in the annual period is their only annual income and will be taxed at standard marginal income tax rates for the year in which it was earned.

Business Taxpayer

For business taxpayers, ordinary income is simply the profit they earn from providing their goods or services.

Consider a corporation that has an annual revenue of $300,000 from selling its products earned in fiscal year (FY) 2022 with qualifying expenses of $60,000, which includes the cost of goods sold, depreciation, and other expenses.

This business would have an ordinary taxable income of $240,000 for FY 2022. A

t an ordinary corporate income tax rate of 21% and no other deductions, this company would pay $50,400 in taxes.

Other Classifications of Income

Other types of income come with their own tax rates, which depending upon the income of the taxpayer, may have much lower tax rates than ordinary income.

One of the most common classifications of income outside of ordinary income is that of long-term capital gains income.

This is a generally lower tax rate that the government charges on investments held for more than a year in order to encourage long-term investments.

Since the Jobs and Growth Tax Relief Reconciliation Act of 2003, the capital gains tax rate has been 15%.

Due to the difference in tax rate between this capital gains rate and the ordinary income rate, it is often beneficial for investors to avoid classifying earnings as ordinary income when it is possible.

For example, if an investor were to purchase a stock, they may consider holding the asset for greater than a year in order to avoid classifying it as ordinary income and benefit from the lower capital-gains rate.

Another common type of income is supplemental income.

This income can include but is not limited to bonuses, tips, commissions, overtime pay, awards, and more.

However, in some cases, these types of income can also be classified as ordinary income.

This may depend upon the choice of either the employer or employee.

However, supplemental income is taxed at a flat rate of 22% regardless of the ordinary marginal tax rate except on supplemental income in excess of $1,000,000.

Qualified Vs. Unqualified Dividends

In some cases, dividends are qualified for lower capital gains tax rates; however, this is not always the case.

Unqualified dividends are paid at an individual’s ordinary income tax rate, whereas qualified dividends are often taxed at a lower rate.

Unqualified dividends include those paid out by employee stock options, dividends from tax-exempt companies, and savings accounts.

Qualified dividends generally include those paid out by for-profit companies.

However, it is important to consider the minimum holding period for these investments.

For common stock shares, an investor must hold the investment for at least sixty days in the 121-day holding period, which starts sixty days prior to the ex-dividend date.

Preferred stocks must be held for at least ninety days during the 180-day holding period starting ninety days prior to the stock’s ex-dividend date.

What Is Ordinary Income for Tax Purposes?

Most of the income people make is taxed at the standard marginal tax rates.

However, some income, such as qualified dividends and long-term capital gains, are taxed at more favorable rates.

Although, it is always important to consult a tax professional for any questions about your taxes.

Is Rent Treated as Ordinary Income?

The Internal Revenue Service defines rent as any payment a person receives for the occupation or use of property, and it is taxed as ordinary income.

But, you can deduct some costs from the rental income in order to reduce the amount you will be taxed on.

The expenses that can be deducted are condominium fees, property taxes, homeowner’s insurance, cleaning and maintenance, mortgage interest, advertising, and the cost of repairs.

Am I Required to Report Interest Income?

In most cases, the interest people receive is taxed as ordinary income.

Therefore, the normal income tax rates would apply.

However, there are some exceptions to this, such as interest that has been earned from either Series l or Series EE bonds that were issued after 1989 and used for paying interest on some bonds used to finance government operations, qualified higher educational expenses, or interest on insurance dividends left on deposit with the U.S. Department of Veterans Affairs.

It is important to remember that the interest must be reported whether it is taxable or not.

Key Takeaways

  • Ordinary income includes any income which is taxed at an ordinary U.S. income tax rate.
  • Common examples of ordinary income for individuals include wages, salaries, tips, commissions, royalties, and nonqualified dividends.
  • For corporations, ordinary income is the income that comes from typical business operations.

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  1. Penn Wharton "How Are Capital Gains and Dividends Taxed?" Page 1 . August 30, 2022

  2. Cornell Law School "26 U.S. Code § 64 - Ordinary income defined" Page 1 . August 30, 2022

  3. Congress.gov "Summary: H.R.2 — 108th Congress (2003-2004)" Page 1 . August 30, 2022