Ordinary Income

What is ordinary income?

Ordinary income is any income taxed at the regular (marginal) income tax rates. It includes wages, salaries, tips, bonuses, commissions, rents, royalties, interest, unqualified dividends, and short-term capital gains. For individuals, ordinary income is typically pretax earnings and most forms of unearned income taxed at ordinary rates. For businesses, ordinary income is the profit from day-to-day operations (operating income), excluding gains from the sale of long-term capital assets.

Key points

• Ordinary income is taxed at marginal (ordinary) tax) rates.
• Common examples: wages, tips, rent, royalties, interest, short-term capital gains, and unqualified dividends.
• Long-term capital gains and qualified dividends are generally taxed at preferential rates and are not treated as ordinary income.
• Deductions can reduce the amount of ordinary income subject to tax.

Individual vs. business ordinary income

• Individuals: Ordinary income is the pretax cash inflow subject to standard income tax brackets (salary, wages, interest, rental income, etc.).
• Businesses: Ordinary income is operating income—revenues from sales or services minus cost of goods sold and operating expenses. It excludes gains from selling capital assets held long term (e.g., land or equipment).

How ordinary income is taxed

Ordinary income is taxed according to marginal tax brackets. The specific bracket rates and thresholds change periodically, so use current tax tables or consult a tax professional when preparing returns. Short-term capital gains and unqualified dividends are taxed at ordinary rates; qualified dividends and long-term capital gains are taxed at lower, preferential rates (commonly 0%, 15%, or 20% depending on taxable income and filing status).

Examples

• Individual: A person earning $3,000 per month from a job has annual ordinary income of $36,000. If they also collect $1,000 per month in rental income, their total ordinary income rises to $48,000 before deductions.
• Business: A company’s ordinary income equals its pretax operating profit—sales revenue less the costs of sales and ordinary operating expenses (payroll, marketing, depreciation, etc.).

Note: taxable ordinary income can be reduced by allowable deductions (standard or itemized, business expenses, rental property expenses, etc.).

Dividends and holding periods

• Qualified dividends generally receive preferential tax rates (0%, 15%, or 20%), depending on taxable income and filing status.
• Unqualified (ordinary) dividends—such as many REIT dividends, certain employee stock option payouts, and some other distributions—are taxed at ordinary rates.
• Holding-period requirements affect dividend qualification:
• Common stock: must be held more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
• Preferred stock: the required holding period is typically longer (beginning 90 days before the ex-dividend date for many preferred shares).

Rental income and deductible expenses

Rental payments are generally taxed as ordinary income. Landlords may reduce taxable rental income by deducting qualifying expenses, such as:

• Mortgage interest
• Property taxes
• Repairs and maintenance
• Advertising
• Property management fees or condo/HOA fees
• Insurance
• Depreciation

Interest income

Most interest income is taxed as ordinary income and must be reported. Some exceptions or tax-advantaged treatments exist (for example, municipal bond interest is often tax-exempt federally; certain U.S. savings bond interest may be excluded if used for qualified higher-education expenses and other rules are met). Even tax-exempt interest may need to be reported on tax returns.

What is not ordinary income

Income that typically is not taxed as ordinary income includes:

• Long-term capital gains (from assets held longer than one year)
• Qualified dividends (subject to preferential rates)

These items are generally taxed at lower rates than ordinary income.

Bottom line

Ordinary income encompasses most day-to-day earnings and many forms of unearned income and is taxed at standard marginal rates. Understanding which receipts are ordinary income, which are taxed more favorably, and what deductions apply helps accurately estimate tax liability and plan effectively. For current rates, bracket thresholds, and specific tax treatment, consult up-to-date IRS guidance or a tax professional.