Ordinary Income: What It Is and How It’s Taxed

What Is Ordinary Income?

Ordinary income is any income earned by an organization or an individual taxable at marginal tax rates. It can include wages, salaries, tips, bonuses, commissions, rents, royalties, short-term capital gains, unqualified dividends, and interest income.

Individual Income vs. Business Income

Ordinary income comes in two forms: personal income and business income. Personal ordinary income can be defined as cash inflow subject to the standard marginal income tax rates and defined by the Internal Revenue Service (IRS).

For businesses, ordinary income is generated from regular day-to-day business operations—excluding any income earned from the sale of long-term capital assets, such as land or equipment.

Marginal Tax Rates

Marginal rates for tax years 2024 and 2025 that are applied to ordinary income for individuals and married couples are:

Examples

Individuals

Ordinary income for individuals typically consists of the salaries and wages earned from their employers before taxes. A person who holds a customer service job at Target and earns $3,000 per month will have a calculated annual ordinary income of $36,000, or $3000 × 12 months.

This $36,000 is taxed on their year-end tax return as gross income. If the individual also owned rental property and earned $1,000 a month in rent, ordinary income would increase to $48,000 per year ($36,000 plus $12,000).

Businesses

A company’s ordinary income is the pretax profit from selling its products or services. Retailer Target made $109.1 billion in total revenue in its fiscal year (FY) ending Jan. 28, 2023. However, those sales cost money to generate.

The company claimed costs attributable to the production of goods sold (COGS) were $82.2 billion. Target also spent $20.6 billion on selling, general, and administrative expenses (SG&As). Factor in depreciation and amortization, and ordinary income or operating income totals $3.9 billion, the amount of income subject to taxation.

Dividends and Taxes

Most stock dividends on long-term investments are subject to a lower rate than ordinary income. The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) reduced the tax on most dividend income and some capital gains to 15%. This change prompted companies to increase or pay dividends instead of holding onto their cash.

In 2017, then-President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) into law, which changed the tax rate on qualified dividends to 0%, 15%, or 20%, based on an individual’s taxable income and filing status. Unqualified dividends include those paid out by real estate investment trusts (REITs), income paid on employee stock options (ESOs), and dividends paid by tax-exempt companies and on savings accounts or money market accounts.

Regular dividends paid out to shareholders of for-profit companies usually qualify for taxation at the reduced capital gains rate, but investors must adhere to minimum holding periods. For common stock, a share must be held for more than 60 days during the 121-day holding period that begins 60 days before the ex-dividend date. For preferred stock, the holding period is longer, beginning 90 days before the company’s ex-dividend date.

The Bottom Line

Ordinary income is taxed at marginal rates. Individuals pay taxes on ordinary income, such as salaries, tips, rent, and interest. Businesses earn ordinary income from business operations while supplying goods and services.