Ordinary Income

Under the United States Internal Revenue Code, the type of income is defined by its character.

Ordinary income is usually characterized as income other than capital gain.

Ordinary income can consist of income from wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, dividends, or net income from a sole proprietorship, partnership or LLC. Rents and royalties, after certain deductions, depreciation 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 a gain from the sale or exchange of a capital asset.

The definition of a 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 Saks Fifth Avenue.

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 the 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. Qualified dividends are dividends paid by domestic corporations or qualified foreign ones which the corporation has included 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.

Cite Term

Definition Sources