Ordinary income
Encyclopedia
Under the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 Internal Revenue Code
Internal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...

, the type of income is defined by its character. Ordinary income is usually characterized as income other than capital gain
Capital gain
A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor...

. Ordinary income can consist of income from wages, salaries, tips, commissions
Commission (remuneration)
The payment of commission as remuneration for services rendered or products sold is a common way to reward sales people. Payments often will be calculated on the basis of a percentage of the goods sold...

, bonuses, and other types of compensation from employment, interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....

, dividends, or net income
Net income
Net income is the residual income of a firm after adding total revenue and gains and subtracting all expenses and losses for the reporting period. Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings...

 from a sole proprietorship
Sole proprietorship
A sole proprietorship, also known as the sole trader or simply a proprietorship, is a type of business entity that is owned and run by one individual and in which there is no legal distinction between the owner and the business. The owner receives all profits and has unlimited responsibility for...

, partnership
Partnership
A partnership is an arrangement where parties agree to cooperate to advance their mutual interests.Since humans are social beings, partnerships between individuals, businesses, interest-based organizations, schools, governments, and varied combinations thereof, have always been and remain commonplace...

 or LLC
Limited liability company
A limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions...

. Rents
Passive income
Passive income is an income received on a regular basis, with little effort required to maintain it.The American Internal Revenue Service categorizes income into three broad types, active income, passive income, and portfolio income...

 and royalties
Royalties
Royalties are usage-based payments made by one party to another for the right to ongoing use of an asset, sometimes an intellectual property...

, after certain deductions
Tax deduction
Income tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...

, depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

 or depletion allowances, and gambling winnings are also treated as ordinary income. A "short term capital gain", or gain on the sale of an asset held for less than one year of the capital gains holding period, is taxed as ordinary income.

Ordinary income stands in contrast to capital gains, which is defined as gain from the sale or exchange of a capital asset. The definition of capital asset under the tax law can be explained by noting that your house is a capital asset to you the homeowner but if you bought it from a land developer who had many houses on many lots, each of those houses was inventory when he sold them and hence was not a capital asset to him, just as clothing would be inventory and not a capital asset to a department store.

Another case where income is not taxed as ordinary income is with qualified dividends. The general rule taxes dividends as ordinary income. A change allowing use of the same tax rates as for long term capital gains rates for qualified dividends was made with the Jobs and Growth Tax Relief Reconciliation Act of 2003
Jobs and Growth Tax Relief Reconciliation Act of 2003
The Jobs and Growth Tax Relief Reconciliation Act of 2003 , was passed by the United States Congress on May 23, 2003 and signed into law by President George W. Bush on May 28, 2003...

. Qualified dividends are dividends paid by domestic corporations or by corporations from foreign countries that have a tax treaty
Tax treaty
Many countries have agreed with other countries in treaties to mitigate the effects of double taxation . Tax treaties may cover income taxes, inheritance taxes, value added taxes, or other taxes...

 with the US. This applies under the condition that the corporation has included the dividends in its own taxable income. Thus passthrough corporations like REITs and REMICs would not distribute qualified dividends and would be taxed at the ordinary income rates.

Rates

In the United States, ordinary income is taxed at the marginal tax rates. As of 2006, there are six "tax brackets" ranging from 10% to 35%. Ordinary income is taxed within the particular tax bracket listed on the rate schedules or tax tables as a percentage for each dollar within that bracket. However, after the 2003 Tax Cut, qualified dividends and long-term capital gains are taxed at the same rate of 15%.

External links

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