Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Courses
  • Find a Job
  • Home
  • Accounting, Taxation, and Reporting
  • Business Taxation

Ordinary Income - Explained

What is Ordinary Income?

Written by Jason Gordon

Updated at April 8th, 2022

Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Marketing, Advertising, Sales & PR
    Principles of Marketing Sales Advertising Public Relations SEO, Social Media, Direct Marketing
  • Accounting, Taxation, and Reporting
    Managerial & Financial Accounting & Reporting Business Taxation
  • Professionalism & Career Development
  • Law, Transactions, & Risk Management
    Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
  • Business Management & Operations
    Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior
  • Economics, Finance, & Analytics
    Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles
  • Courses
+ More

Table of Contents

What is Ordinary Income?How Does Ordinary Income Work? Examples of Ordinary IncomeSpecial ConsiderationsQualified Vs. Unqualified DividendsAcademic Research on Ordinary Income

What is Ordinary Income?

An ordinary income is a pretax income earned by individuals and organizations which is taxable using ordinary rates. Examples of ordinary income are salaries, wages, interests earned on bonds, tips, commissions and other forms of income different from long-term capital gains. Long-term capital gains are not ordinary income, they are regarded as dividends and are subject to a tax treatment different from that or ordinary income. Long-term capital gains are earned fro investments held for a period longer than one year.

Back to: Accounting & Taxation

How Does Ordinary Income Work? 

Ordinary income earned by organizations is called business income while individuals earn personal income. There are many ways to generate ordinary income, for instance, businesses can generate ordinary income from their day to day activities or sale of products while individuals earn ordinary income as salaries, tips, wages, and commissions. Income made from the sale of long-term assets does not qualify as ordinary income, such income has a different tax treatment. The Internal Revenue Service (IRS), outlines the cash that qualifies as ordinary income, both for individuals and organizations. Here are some points to know about ordinary income;

  • Ordinary income is earned by individuals and organizations and is taxable at ordinary rates.
  • Ordinary income for individuals includes salaries, wages, tips, and commissions while organizations also earn ordinary income from interest from bonds, commissions, and others.
  • Long-term capital gains earned from investments held for a period longer than one year is subjected to different tax treatment. Long-term capital gains do not qualify as ordinary income, given that they are dividends earned form long-term investments.

Examples of Ordinary Income

If a business development personnel at an organization earns a salary of $2,000 per month, this is an example of ordinary income. In addition to his salary, if the employee earns commission from a business referral or receives tips from clients, they also qualify as ordinary income, ordinary income is taxed using ordinary rates. In addition, if an individual property owner earns an amount as rental income of properties let out to people, such income is also ordinary income. The Internal Revenue Service (IRS) treats pretax profit earned by companies through the sales of products and services as ordinary income. Companies or organizations are required to report their annual income to the IRS for tax purposes. Ordinary income is taxed using ordinary rates, this type of income differs from long-term capital gains.

Special Considerations

Capital gains earned on long-term investments and assets attract lower tax rates than ordinary income. The reason is that the government tries to encourage investment in long-term assets through the introduction of lower tax rates on capital gains. Before the introduction of lower tax rates, dividends, or capital gains were treated as ordinary income and taxed the same.

Qualified Vs. Unqualified Dividends

Not all dividends enjoy the lower tax rates offered by the IRS, to avoid confusion, the IRS separates qualified dividends from unqualified dividends. There are certain eligibility requirements that dividends must meet before they are qualified for favorable tax treatment. Examples of dividends that are unqualified for favorable tax treatments are dividends paid by master limited partnerships (MLPS), real estate investment trusts (REITs) and others. Dividends collected from tax-exempt companies and money market are also unqualified for favorable tax treatment.


Was this article helpful?

Yes
No

Related Articles

  • Tax Shelter - Explained
  • Accelerated Deposit Rule - Explained
  • Flat Tax - Explained
  • Double Taxation - Explained



©2011-2023. The Business Professor, LLC.
  • Privacy

  • Questions

Definition by Author

0
0
Expand