What is Ordinary Income
Ordinary income traditionally refers to the income from wages, salaries, commissions, tips, income earned from the business, rents, and excluding all the long-term capital gains like income from transactions and income from property selling.
Types of Income Taxed at The Ordinary Income Tax Rates are
- Other employment compensation
- Interest income
- Income from a business
- Rents/royalties (after certain allowances)
- Short-term capital gains (held for a year or less)
- Unqualified dividends
Ordinary income can be distinguished by two terms which are long-term capital gain and short-term capital gain.
Long-term capital gain is taxed at more favorable rates which range from 0 percent to 20 percent. The government imposes lower tax rates on long-term capital gain because they want the public to invest in more long-term capital gain. Capital gain is referred to the income generated by selling the property.
And short-term capital gain is generating money from the business, rents, hourly paid jobs, etc.
Example of Ordinary Income:
If you are working as an individual for which you are getting paid for every hour, so your hourly wage is considered as your ordinary income. Like if an individual is earning $5000 per month, so the total ordinary income will be calculated by multiplying the earning by 12 which is equal to $60000 if an individual is not doing any other job.
And if the individual is having some other ways of earning as well the ordinary income will be the addition of amount/income and then multiplying that by 12.
Another example would be is if you are a business owner and the income you earn falls under the ordinary income. And the total income earned will be the addition of the amount generated per month for 12 months.
Considerations on Ordinary Income:
The government imposes lower tax rates on long-term capital gain because to encourage people to invest in stocks and long-term projects. Until the end of 2017, the taxes imposed on long-term capital gain was about 15% percent but at the end of 2017 president, Trump made the taxes depending on an individual taxable income and filing status which was categorized into 0%, 15%, or 20%.
A corporation is taxed doubled. That means the government imposes taxes on the business when it earns a profit. Then, the business/corporation is taxed again when it distributes dividends to its owners.
Corporation owners are paid with dividends, or distributions of company profits. If an individual owns a corporation, he or she might receive dividends as cash payments, stock shares, or other property.
Dividends can be taxed as ordinary income or capital gains, depending on the type of dividend.
Qualified Dividends and Unqualified Dividends:
Not all dividends are equal, and investors need to be aware of this fact. There are many differences that can make a big impact.
There are basically two different types of dividends that are qualified and unqualified. Understanding the difference between the two dividends is a big deal for investors around tax time as the tax implications can affect the maximum return on investment.
The Big Difference between a qualified dividend is a type of dividend that is taxed at the capital gains tax rate. Most regular dividends from U.S. companies or businesses with normal company structures are qualified.
For individuals, the qualified dividends are taxed at the current capital gains rate of 15%. For individuals whose income tax rate is between 10% or 15%, then the capital gains tax rate turns to be zero.
These qualified dividend rates are lower than the typical income tax rate that applies to unqualified, or ordinary dividends. Unqualified dividends do not qualify for the lower tax preference and are thus taxed at an individual’s normal income tax rate. Regardless of your tax bracket, this difference means that an individual or business will have to pay higher taxes on unqualified dividends.
Requirement for Qualified Dividends:
Investors must meet certain requirements to enjoy the lower tax rate. Investors must have a minimum holding period. For common stock, a share must be held for more than 60 days during the 120 days beginning 60 days before the ex-dividend date.
For some stocks, the holding period is 90 days during the 180 days beginning 90 days before the stock’s ex-dividend date.
So, if an investor is paid a dividend by any company and they meet the holding period criteria then those dividends are qualified. If the holding period is not met, then the dividend is unqualified, and an individual is thus taxed at the normal income tax rate.
In the United States, ordinary income is being taxed at marginal tax rates. There are six “tax brackets” that range from 10% to 35% which were decided in 2006. Ordinary income is taxed within the specific tax bracket listed on the rate schedules as a percentage for each dollar within that bracket. Although, after the Tax Cut in 2003, qualified dividends and long-term capital gains were taxed at the same rate of 15%.