What Is Included in Ordinary Income?

In the U.S. tax system, nearly all income is subject to taxation unless specifically exempted. This income is broadly categorized, with the most common type being ordinary income, which represents money earned from sources like employment and business activities. Ordinary income is taxed at standard federal rates, which are different from the preferential rates applied to other income types, such as long-term capital gains.

Common Sources of Ordinary Income

Ordinary income comes from many sources. The most common forms include:

• Compensation for services, which includes wages, salaries, tips, commissions, and bonuses received from an employer.
• Self-employment income, where the net income from business operations for freelancers or independent contractors is considered ordinary income.
• Interest income earned from bank accounts, certificates of deposit (CDs), and most types of bonds.
• Non-qualified dividends, which are dividends that do not meet the specific criteria to be “qualified” and are taxed as ordinary income.
• Rental and royalty income, which includes payments received for the use of real estate or personal property, as well as royalties from copyrights and patents.
• Short-term capital gains, which are profits from the sale of an asset, such as stocks or real estate, that was held for one year or less.
• Retirement plan distributions, where withdrawals from traditional retirement plans like 401(k)s and IRAs are taxed as ordinary income in the year they are received.
• Other income, as various other streams are treated as ordinary income, including unemployment compensation, gambling winnings, and any income generated from a hobby.

Income Not Classified as Ordinary

To understand ordinary income, it helps to know what is not included. Certain types of income and receipts have different tax treatments or are not considered taxable income at all.

• Long-term capital gains are profits from the sale of assets held for more than one year and are taxed at lower, preferential rates.
• Qualified dividends must meet specific criteria regarding the paying corporation and how long the stock was held. They are taxed at the same lower rates as long-term capital gains.
• Gifts and inheritances are received tax-free by the recipient. Any potential gift or estate tax is the responsibility of the giver or the estate.
• Life insurance proceeds paid to a beneficiary due to the death of the insured are not taxable income.
• Child support payments are not taxable to the recipient nor deductible by the payer.

Tax Treatment of Ordinary Income

The United States has a progressive tax system, where higher levels of ordinary income are taxed at higher rates. The system uses income ranges called tax brackets, each with a marginal tax rate. For the 2024 tax year, the rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

The concept of marginal tax rates means that not all of a person’s income is taxed at the same rate. Instead, income fills up the tax brackets in sequence. For example, the first portion of income is taxed at the 10% rate, the next portion at the 12% rate, and so on, until all income is accounted for.

This progressive structure for ordinary income contrasts with the treatment of long-term capital gains and qualified dividends. These income types are subject to their own rates of 0%, 15%, and 20%, depending on the taxpayer’s income level.

Reporting Ordinary Income on Tax Forms

Reporting ordinary income to the IRS involves several documents. Employers report wages, salaries, and tips on Form W-2. Other types of ordinary income are reported on a series of 1099 forms, such as Form 1099-INT for interest income and Form 1099-DIV for dividends.

Independent contractors or freelancers receive Form 1099-NEC for nonemployee compensation from clients who paid them $600 or more. Rental income is reported on Schedule E, while business income for a sole proprietor is on Schedule C.

All of these income streams are ultimately aggregated on Form 1040, the U.S. Individual Income Tax Return. It is the taxpayer’s responsibility to report all ordinary income, even if a corresponding form like a W-2 or 1099 is not received.