What is Ordinary Income?

Explanation

  • Ordinary income is the type of income taxed at ordinary rates, and it is earned regularly from day to day operations. It does not include capital gains and qualified dividendsQualified DividendsQualified dividends are labeled as ordinary and meet all of the requirements to be taxed at CG (capital gains) rates rather than the higher income tax rates that apply to ordinary and non-qualified dividends. A qualifying international entity or a U.S. company pays these.read more, which are taxed at lower rates.Unqualified dividends are taxed at ordinary rates of tax, for example, dividends paid by REIT (Real Estate Investments Trust), income paid on ESO (Employee Stock optionsEmployee Stock OptionsEmployee stock option plan (ESOP) is an “option” granted to the company employee which carries the right, but not the obligation, to buy a promised number of shares at a pre-determined price (known as exercise price). read more), income from money market operations.Salaries and wages received by the individual from his employment can be considered as the best example. There are many other examples like rent received, business and trading income, etc.

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Ordinary Income Examples

  • Tips received by hotel staff due to its periodic nature;Salaries, wages earned by engaging inInterestRentUnqualified dividendsBusiness income

How Does Ordinary Income Works?

  • Ordinary  Income can be in two forms i.e., business income and personal incomePersonal IncomePersonal income refers to the total earnings of the individuals and households of a nation through multiple sources such as salary, wages, business profits, bonus, investment returns, dividends, rental receipts, employer contribution in provident or pension funds, etc.read more.Business income is earned from day to day business operations except for income from capital gains i.e., income from the sale of capital assets, or for example, income earned from the regular sale of land, buildings, etc.Personal income means any cash inflow which is subject to income tax as defined by IRS (Internal Revenue Service)

Substitutes

#1 – If the transaction involves income either in the present or future, then that transaction is considered as ordinary income.

For Example: If the business is engaged in buying cars and reselling cars for profit after some modifications made to cars, then the income earned from selling that used cars will be considered as ordinary income but not capital gain.

#2 – Money earned from an asset.

For Example, Interest earned from a savings bank account, rent earned from the property.

Ordinary Income Tax Rate 2019

Tax rates in India for the financial year 2019 – 2020 are given below:

Applicable surcharge + 4% health and education cess is applicable.

For companies, partnership firms-  Tax rate is at the flat rateTax Rate Is At The Flat RateA flat tax is a taxation system whereby a uniform tax rate applies to all taxpayers irrespective of their income. read more of 30% + applicable surcharge w 4% health and education cess

Ordinary Income vs. Capital Gain

Advantages

  • A basic exemption limit is given to individuals within that income limit, so no need to pay tax.Individuals, HUF, BOI ( Body of individuals) need to pay tax according to their income levels at prescribed rates for different income levels.

Disadvantages

  • Companies and partnership firms need to pay at a rate of 30%+ surchargeSurchargeA surcharge is an extra fee or tax added to the customer’s final bill for paying through check, credit, or debit card rather than cash. The additional sum reflects the extra services offered by the merchant, increased product costs, or government regulatory costs. It could be either a fixed amount or a percentage of the purchase amount.
  • read more if applicable+4% health and education cess. Even if there is a small amount of profit earned, one needs to pay tax at prescribed rates.

Conclusion

  • It is the income regularly earned from day to day operations or activities, and it does not include qualified dividends, capital gains. Individuals are taxed at the prescribed rates according to their income levels, but companies and partnership firms are taxed at fixed rates irrespective of their income levels.There are two forms of Ordinary income i.e., personal income and other is business income. Personal income is the income earned from any activity which is subject to income tax; business income is the income earned before taxes i.e., PBT (profits before taxesProfits Before TaxesProfit before tax (PBT) is a line item in a company’s income statement that measures profits earned after accounting for operating expenses like COGS, SG&A, depreciation & amortization, and non-operating expenses. It gives the overall profitability and performance of the company before making payments in corporate taxes.read more). There are some deductions and exemptions that are allowed while paying taxes.On the other hand, the government is encouraging people to invest in government bonds, shares, stock, etc. by taxing them at lower rates on the income earned by the people from these investments.

This article has been a guide to ordinary income and its definition. Here we discuss characteristics, examples, and how ordinary income works along with its tax rate and advantages and its comparison to Capital Gains. You may learn more about financing from the following articles –

  • Unearned IncomeInvestment IncomeTax Loss Harvesting ExampleCapital Loss Formula