What Is Ordinary Income?
Ordinary income encompasses any income earned by an organization or individual that is taxable at marginal tax rates. This can include wages, salaries, tips, bonuses, commissions, rents, royalties, short-term capital gains, unqualified dividends, and interest income.
Key Takeaways
- Ordinary income is any income taxable at marginal rates.
- Examples of ordinary income include salaries, tips, bonuses, commissions, rents, royalties, short-term capital gains, unqualified dividends, and interest income.
- For individuals, ordinary income usually consists of the pretax salaries and wages they have earned.
- In a corporate setting, ordinary income comes from regular day-to-day business operations, excluding income gained from selling capital assets.
Comparing Individual and Business Income
Ordinary income manifests in two primary forms: personal income and business income. Personal ordinary income consists of cash inflow subject to the standard marginal income tax rates, as defined by the Internal Revenue Service (IRS).
For businesses, ordinary income arises from regular day-to-day operations—excluding income from selling long-term capital assets, such as land or equipment. Long-term capital gains and qualified dividends are taxed differently and do not qualify as ordinary income.
Marginal Tax Rates
Marginal tax rates for ordinary income in the tax years 2023 and 2024 for individuals and married couples are:
2023 Tax Year
| Income | Individual Single Taxpayer | Income | Married Couples Filing Jointly |
|---|---|---|---|
| 37% | Over $578,125 | 37% | Over $693,750 |
| 35% | Over $231,250 | 35% | Over $462,500 |
| 32% | Over $182,100 | 32% | Over $364,200 |
| 24% | Over $95,375 | 24% | Over $190,750 |
| 22% | Over $44,725 | 22% | Over $89,450 |
| 12% | Over $11,000 | 12% | Over $22,000 |
| 10% | Less than $11,000 | 10% | Less than $22,000 |
2024 Tax Year
| Income | Individual Single Taxpayer | Income | Married Couples Filing Jointly |
|---|---|---|---|
| 37% | Over $609,350 | 37% | Over $731,200 |
| 35% | Over $243,725 | 35% | Over $487,450 |
| 32% | Over $191,950 | 32% | Over $383,900 |
| 24% | Over $100,525 | 24% | Over $201,050 |
| 22% | Over $47,150 | 22% | Over $94,300 |
| 12% | Over $11,600 | 12% | Over $23,200 |
| 10% | Less than $11,600 | 10% | Less than $23,200 |
Real-World Examples
Individuals
For individuals, ordinary income typically consists of salaries and wages earned from employers before taxes. Suppose an individual holds a customer service job earning $3,000 per month. The calculated annual ordinary income would be $36,000 ($3,000 x 12 months).
Additionally, if this individual owns rental property and earns $1,000 a month in rent, the ordinary income would rise to $48,000 per year ($36,000 + $12,000). Tax deductions can reduce the taxable amount of this ordinary income.
Businesses
A company’s ordinary income is derived from the pretax profit of selling products or services. For instance, a retailer reports $109.1 billion in total annual revenue. After deducting costs attributable to producing goods sold (e.g., $82.2 billion) and expenses like selling, general, and administrative costs (e.g., $20.6 billion), and factoring in depreciation and amortization, the ordinary income totals $3.9 billion. This amount is then subject to taxation.
Dividends and Taxes
Most stock dividends on long-term investments are subject to a lower rate than ordinary income. Legislative changes have influenced tax rates on dividends. For instance, the Jobs and Growth Tax Relief Reconciliation Act of 2003 reduces tax on most dividend income to 15%. Subsequently, the Tax Cuts and Jobs Act (TCJA) established variable tax rates of 0%, 15%, or 20% for qualified dividends, based on an individual’s taxable income and filing status.
However, unqualified dividends, such as those from Real Estate Investment Trusts (REITs) or employee stock options (ESOs), are taxed at ordinary income rates. Besides, investors must adhere to certain holding periods to benefit from the favorable tax rates on qualified dividends.
Understanding Taxation on Ordinary Income
Most of an individual’s income will be taxed at regular marginal tax rates. Notable exceptions to this rule include long-term capital gains and qualified dividends, which are taxed at more favorable rates.
Tax Implications of Rental Income
According to the IRS, rental income constitutes “any payment for the use or occupation of property” and is generally taxed as ordinary income. However, landlords can deduct legitimate expenses such as mortgage interest, property tax, repair costs, advertising, maintenance, cleaning fees, condo or homeowners’ association fees, and insurance to reduce the taxable rental income amount.
Reporting of Interest Income
Most interest income is taxed as ordinary income at standard tax rates. However, some exceptions exist, including interest earned from Series EE or I bonds issued after 1989, where the proceeds are used for qualified higher educational expenses, and certain government bonds and insurance-related interest income.
The Bottom Line
Ordinary income is subject to taxation at marginal rates, affecting both individuals and companies. Understanding and correctly reporting ordinary income can significantly influence overall tax liabilities for both personal and business finance.
Related Terms: capital gains, qualified dividends, tax rates, gross income, unqualified dividends, interest income.
References
- Internal Revenue Service. “Publication 525 Taxable and Nontaxable Income”.
- Internal Revenue Service. “Publication 550, Investment Income and Expenses”.
- Internal Revenue Service. “Topic No. 409 Capital Gains and Losses”.
- Internal Revenue Service. “Rev. Proc. 2023-34”, Pages 5-7.
- Internal Revenue Service. “Rev. Proc. 2022-38”, Pages 5-8.
- Internal Revenue Service “Credits and Deductions for Individuals”.
- Target Corporation. “2022 Annual Report”, Page 21.
- Target Corporation. “2022 Annual Report”, Page VI (PDF Page 6).
- U.S. Congress. “H.R.2 — Jobs and Growth Tax Relief Reconciliation Act of 2003”.
- U.S. Congress. “H.R.1 - An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018”.
- Internal Revenue Service. “Rental Income and Expenses - Real Estate Tax Tips”.
- Internal Revenue Service. “Topic No. 403 Interest Received”.
