What is ordinary income?
In broad terms, ordinary income is money earned from working. This includes hourly wages, salaries, tips, commissions, interest earned from bonds, income earned from a business, some rents and royalties, short-term capital gains that are held for no more than a year, and unqualified dividends.
It excludes anything that can be classified as long-term capital gain, which in most cases refers to the sale of a property and the income derived from that transaction.
One thing that sets apart ordinary income is the way that it’s taxed. Ordinary income is distinguished from long-term capital gain not only in what it is, but also in how it’s taxed.
Long-term capital gain is taxed at what’s often called a favorable or more preferential rate, which can be as little as zero percent up to 20 percent. The government imposes lower, more favorable rates on long-term capital gains because it wants to encourage people to make long-term investments.
Capital gain refers to money made from the sale of a property, which is why most income earned is ordinary income. Unless you buy a property and then sell it later, most of your income will come from salary and wages, from income you earn by running your own business, from interest earned on investments and from similar activities.
Find out what tax bracket you fall into, and know how much tax you’ll pay on your income.
Ordinary income example
For the average person, much if not all of the money he or she earns is considered ordinary income.
For example, if you have a job for which you get paid by the hour, your hourly wage is considered ordinary income.
This applies to your entire paycheck and all of the money you make from this job, including any tips or commissions. This also applies if you work for yourself. For example, if you’re a business owner, income you earn from that business falls under the classification of ordinary income.
Wondering if money you made counts as a capital gain? Here’s how to find out if that money is subject to a capital gains tax.