What is Ordinary Income?

Malcolm Tatum

Ordinary income is any type of income that is considered taxable at the highest rates currently in place. Income of this type includes wages and salaries, any type of commissions that are received in addition to wages and salaries, or any type of interest income that is generated from bond issues or savings accounts. Dividends from other types of investments are often classified as ordinary income. When filing income tax returns, the taxation on the ordinary income generated during the period is offset by any standard tax deductions currently allowed.

The interest generated from savings accounts is considered ordinary income.
The interest generated from savings accounts is considered ordinary income.

In order to properly calculate the amount of ordinary income that is subject to taxation, all types of wages or salaries are included in the total figure earned for the tax period. For people who work for an employer, this is usually handled automatically, with state and federal taxes withheld for the employee and forwarded to the correct tax agency. For people who set up a sole proprietorship, any payments received from their clients is often treated as ordinary income. Depending on the laws relating to the collection of taxes, the individual who is self-employed may need to track income and remit taxes on a monthly, quarterly, or semi-annual basis. In some nations, people who are self-employed and generate under a certain amount of ordinary income may be allowed to make an annual tax payment, without incurring any type of penalties.

When filing an annual tax return, the total amount of taxable ordinary income is reduced by any of the standard deductions allowed by that tax agency. In some cases, these standard deductions are sufficient to reduce the overall tax burden significantly. For people who generate a smaller amount of income during the calendar year, the deductions may be sufficient to lower the taxable income amount to the point that they qualify for a tax refund. People who generate a higher amount of income and do not have much in the way of qualifying deductions may find that they owe additional taxes at the time the return is filed, if sufficient withholding did not take place during the time period covered by the return.

In extremely rare situations, any income that is identified as capital gains may be treated as ordinary income for purposes of taxation. This is sometimes the case when short term capital gains are involved. Since tax laws vary from one country to the next, it is important to check with tax authorities who can evaluate the nature of the gain and advise the taxpayer on whether it is subject to the usually lower capital gains tax or the higher ordinary income tax.

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