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Ordinary Income: Definition & How It Is Taxed?

Updated: November 23, 2022

Your ordinary income is any income that you gain from business activities. Whether that’s working 9-5 for a company, or venturing out on your own as a new startup business.

Unfortunately, every cent that you earn is subject to income taxes, and the majority of your tax bill will be made up of what you’ve earned through ordinary income.

Read on as we take a closer look at what exactly ordinary income is, and show you exactly how it is taxed.

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    KEY TAKEAWAYS

    • Ordinary income is any money that is earned or received from employment or business activities. It gets taxed based on the tax rates outlined by the IRS.
    • Some of the most common forms of ordinary income include hourly wages, yearly salaries, bonuses, commissions, tips, and royalties for example.
    • Ordinary income is often a combination of wages and pretax salaries for individuals.
    • Ordinary income relates to day-to-day business operations for corporations. This doesn’t include income earned from the sale of a capital asset.

    What Is An Ordinary Income? 

    Ordinary income can also get referred to as earned income. It’s any money that’s earned or received from your employer or through business activities. Ordinary income earnings are then subject to various tax rates outlined by the Internal Revenue Service (IRS).

    These include income tax, the marginal income tax rate, and ordinary tax rates. Some of the more common forms of ordinary income include an annual salary, hourly wages, bonuses, or earned commissions. If you’re a sole proprietor and operate your own business, ordinary income is the same as self-employment earnings, or personal income.

    Individuals and businesses get taxed differently depending on the specific type of earnings. Any earnings get classified or categorized as ordinary or unearned income, which can also get referred to as passive income.

    Turn Tax Pains Into Tax Gains

    How Is Ordinary Income Calculated? 

    Ordinary income gets calculated by adding the relevant and necessary income streams for an individual or business. On top of wages and salaries, there can be different forms of income, including the following: 

    • Short-term capital gains
    • Interest earned from bonds 
    • Royalties
    • Employee stock options
    • Annuity and retirement plan distributions 
    • Rental property income 
    • Ordinary or unqualified dividend income
    • Interest income

    Anything that can be classified as a long-term gain is excluded from ordinary income, such as various long-term investment income. 

    What Is Taxed As Ordinary Income?

    The IRS determines the federal tax rates you must pay based on annual earnings. This is called a marginal tax rate and it increases as the level of income rises. Most income gets taxed at the marginal tax rate and it can provide more favorable tax treatment. 

    However, there are a few exceptions worth highlighting. Certain qualified dividends and long-term capital gains can see even more favorable tax rates. There are certain eligibility requirements but this can help reduce tax liability 

    Ordinary Income vs. Unearned Income 

    There are some major differences between ordinary and unearned income, including how they’re taxed and earned. 

    The simplest way to understand ordinary income is that it’s going to be actively earned. For example, you receive an hourly wage at your job in return for your work or annual income. This income gets taxed at marginal tax rates which can often be higher compared to unearned income. 

    Unearned income, on the other hand, is passive income. This could be an asset that was purchased and has continued to appreciate in value. Unearned income gets taxed at more favorable rates and can range from 0 percent to 20 percent. 

    It's Time For Owners To Own Tax Season

    Example of Ordinary Income 

    Ordinary income is fairly straightforward to understand, although it can differ a little bit between an individual and a business. Let’s take a closer look at an example of ordinary income for an individual. 

    Ordinary income will typically include the likes of an hourly wage or a salary that’s earned from their employer. Let’s say that Jennifer works at Walmart and earns $2,500 per month. To find her annual ordinary income, she would multiply her monthly earnings by 12. 

    2,500 x 12 = 30,000

    Jennifer doesn’t have any other taxable income sources. In this case, she would get taxed on her $30,000 on her year-end tax return. But, if Jennifer had income from a rental property, that would get added on top of her yearly earnings, increasing her ordinary income. 

    Summary 

    Ordinary income is any type of income that’s earned by a business or individual and is subject to ordinary tax rates. Some of the most common types of ordinary income include yearly salaries, hourly wages, bonuses, commissions, and interest income to name a few. 

    Different levels of income get taxed at varying rates and it can depend on the type of earnings. There can be preferential rates compared to ordinary rates based on single taxpayer incomes. As well, earnings will then get categorized as either unearned or earned income. 

    For businesses and corporations, ordinary income is generated through day-to-day business operations. It gets taxed based on federal income tax rates and individual tax brackets.

    Less Taxin'. More Relaxin'

    FAQs About Ordinary Income

    How Do I Report Ordinary Income on My Tax Return?

    When you file your tax return, you will include your ordinary income amount. You can work with your employer to ensure you receive the proper documentation.

    What Is the Difference Between Ordinary and Capital Income?

    Ordinary income is generated and earned through things such as wages, salaries, and interest income. Capital income is generated through the sale of a capital asset, such as a stock.

    What Is the Opposite of Ordinary Income?

    The opposite of ordinary income would be capital gains or capital income. Ordinary income is earned by an individual or business through labor or business activities. Capital gains are generated through a sale or exchange of an asset.

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