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What is ordinary income?
Ordinary income is income that is taxed at ordinary income tax rates and does not qualify for capital gains tax treatment. It’s important to understand the difference between ordinary income and capital gain income because, generally, ordinary income tax rates are higher than capital gains tax rates.
It may be easier to understand what ordinary income is by understanding what it is not — it is not capital gain income from the sale or exchange of assets, or income from the sale of certain property used in a trade or business (Section 1231 property).
Ordinary income can be derived from:
- Wages, salaries, tips, and other employment compensation
- Interest earned on savings and investments
- Business and farm income
- Taxable portions of distributions from IRAs, retirement plans, and annuities
- Rents and royalties
- Unemployment compensation
- Taxable portions of Social Security payments
- Gambling winnings
In order to understand how ordinary income affects your tax liability, you should know what ordinary income is, how it is taxed, when it is preferable to capital gain income, and how to accelerate or defer the recognition of ordinary income.
Qualifying dividends paid to individual shareholders are taxed at long-term capital gains tax rates.
Taxation of ordinary income
Generally speaking (and with limitations), ordinary income is reduced by ordinary losses and deductions. The balance is taxed at ordinary income tax rates. Ordinary income rates tend to be less favorable than long-term capital gains tax rates. As a result, investors generally prefer long-term capital gains to ordinary income. However, there are times when ordinary income may produce a more favorable tax result.
Ordinary income may be preferable on occasion
Ordinary income is preferable if you have ordinary losses or deductions items that can be used to reduce your taxable income. Your personal situation may also dictate a need for ordinary income earnings.
Accelerating or deferring ordinary income
The main strategies to accelerate or defer ordinary income focus on the timing of investment purchases and sales. (Retirement strategies also provide opportunities to defer or generate ordinary income.)
How is ordinary income taxed?
Ordinary income is taxed at ordinary income tax rates. These rates depend on your filing status and the amount of your taxable income.
Ordinary tax rates and filing status
In order to ascertain the tax rate applicable to your ordinary income, you must first know your filing status.
The tax rate schedules for 2025 are as follows:
Single:
| Not over $11,925 | 10% of taxable income |
| Over $11,925 to $48,475 | $1,192.50 + 12% of the excess over $11,925 |
| Over $48,475 to $103,350 | $5,578.50 + 22% of the excess over $48,475 |
| Over $103,350 to $197,300 | $17,651 + 24% of the excess over $103,350 |
| Over $197,300 to $250,525 | $40,199 + 32% of the excess over $197,300 |
| Over $250,525 to $626,350 | $57,231 + 35% of the excess over $250,525 |
| Over $626,350 | $188,769.75 + 37% of the excess over $626,350 |
Married filing jointly and surviving spouses:
| Not over $23,850 | 10% of taxable income |
| Over $23,850 to $96,950 | $2,385 + 12% of the excess over $23,850 |
| Over $96,950 to $206,700 | $11,157 + 22% of the excess over $96,950 |
| Over $206,700 to $394,600 | $35,302 + 24% of the excess over $206,700 |
| Over $394,600 to $501,050 | $80,398 + 32% of the excess over $394,600 |
| Over $501,050 to $751,600 | $114,462 + 35% of the excess over $501,050 |
| Over $751,600 | $202,154.50 + 37% of the excess over $751,600 |
Married individuals filing separately:
| Not over $11,925 | 10% of taxable income |
| Over $11,925 to $48,475 | $1,192.50 + 12% of the excess over $11,925 |
| Over $48,475 to $103,350 | $5,578.50 + 22% of the excess over $48,475 |
| Over $103,350 to $197,300 | $17,651 + 24% of the excess over $103,350 |
| Over $197,300 to $250,525 | $40,199 + 32% of the excess over $197,300 |
| Over $250,525 to $375,800 | $57,231 + 35% of the excess over $250,525 |
| Over $375,800 | $101,077.25 + 37% of the excess over $375,800 |
Heads of household:
| Not over $17,000 | 10% of taxable income |
| Over $17,000 to $64,850 | $1,700 + 12% of the excess over $17,000 |
| Over $64,850 to $103,350 | $7,442 + 22% of the excess over $64,850 |
| Over $103,350 to $197,300 | $15,912 + 24% of the excess over $103,350 |
| Over $197,300 to $250,500 | $38,460 + 32% of the excess over $197,300 |
| Over $250,500 to $626,350 | $55,484 + 35% of the excess over $250,500 |
| Over $626,350 | $187,031.50 + 37% of the excess over $626,350 |
Trusts and estates:
| Not over $3,150 | 10% of taxable income |
| Over $3,150 to $11,450 | $315 + 24% of the excess over $3,150 |
| Over $11,450 to $15,650 | $2,307 + 35% of the excess over $11,450 |
| Over $15,650 | $3,777 + 37% of the excess over $15,650 |
The tax rate schedules for 2024 are as follows:
Single:
| Not over $11,600 | 10% of taxable income |
| Over $11,600 to $47,150 | $1,160 + 12% of the excess over $11,600 |
| Over $47,150 to $100,525 | $5,426 + 22% of the excess over $47,150 |
| Over $100,525 to $191,950 | $17,168.50 + 24% of the excess over $100,525 |
| Over $191,950 to $243,725 | $39,110.50 + 32% of the excess over $191,950 |
| Over $243,725 to $609,350 | $55,678.50 + 35% of the excess over $243,725 |
| Over $609,350 | $183,647.25 + 37% of the excess over $609,350 |
Married filing jointly and surviving spouses:
| Not over $23,200 | 10% of taxable income |
| Over $23,200 to $94,300 | $2,320 + 12% of the excess over $23,200 |
| Over $94,300 to $201,050 | $10,852 + 22% of the excess over $94,300 |
| Over $201,050 to $383,900 | $34,337 + 24% of the excess over $201,050 |
| Over $383,900 to $487,450 | $78,221 + 32% of the excess over $383,900 |
| Over $487,450 to $731,200 | $111,357 + 35% of the excess over $487,450 |
| Over $731,200 | $196,669.50 + 37% of the excess over $731,200 |
Married individuals filing separately:
| Not over $11,600 | 10% of taxable income |
| Over $11,600 to $47,150 | $1,160 + 12% of the excess over $11,600 |
| Over $47,150 to $100,525 | $5,426 + 22% of the excess over $47,150 |
| Over $100,525 to $191,950 | $17,168.50 + 24% of the excess over $100,525 |
| Over $191,950 to $243,725 | $39,110.50 + 32% of the excess over $191,950 |
| Over $243,725 to $365,600 | $55,678.50 + 35% of the excess over $243,725 |
| Over $365,600 | $93,334.75 + 37% of the excess over $365,600 |
Heads of household:
| Not over $16,550 | 10% of taxable income |
| Over $16,550 to $63,100 | $1,655 + 12% of the excess over $16,550 |
| Over $63,100 to $100,500 | $7,241 + 22% of the excess over $63,100 |
| Over $100,500 to $191,950 | $15,469 + 24% of the excess over $100,500 |
| Over $191,950 to $243,700 | $37,417 + 32% of the excess over $191,950 |
| Over $243,700 to $609,350 | $53,977 + 35% of the excess over $243,700 |
| Over $609,350 | $181,954.50 + 37% of the excess over $609,350 |
Trusts and estates:
| Not over $3,100 | 10% of taxable income |
| Over $3,100 to $11,150 | $310 + 24% of the excess over $3,100 |
| Over $11,150 to $15,200 | $2,242 + 35% of the excess over $11,150 |
| Over $15,200 | $3,659.50 + 37% of the excess over $15,200 |
Marginal tax rates
A tax bracket expresses the income tax rate for a given range of income. Ordinary income tax rates are progressive. In other words, the tax rate increases on successively greater earnings. Tax brackets measure this progressive tax structure. The marginal tax rate expresses your rate of tax on your next dollar of income. Currently, the top marginal tax rate for ordinary income is 37%. Your effective rate of tax may be greater or less than your marginal rate, depending on the availability of certain losses and deductions. In any event, the marginal rate can provide a quick measure of the tax cost of your investment earnings.
Effective tax rates
The effective tax rate measures your actual tax liability as a percentage of your taxable income. In other words, this measures what you actually pay in taxes after considering disallowed deductions or losses. When your taxable income exceeds your true economic income, the effective tax rate is greater than your marginal tax rate. This provides the best measure of the tax cost of your investment earnings.
When is ordinary income preferable?
Ordinary income may be preferable for both tax and nontax reasons.
Ordinary income may be preferable for nontax reasons
You may need a stream of income from investments to live on or to supplement your earnings from other sources. You may feel that selling an income-producing investment may not be wise (from an investment standpoint). By pursuing a particular investment strategy that emphasizes diversification or minimizes risk, you may want to include bonds and money market mutual funds in your portfolio, which pay interest. So, your personal needs and your investment strategy — not taxes — may dictate your investment holdings and may consequently dictate the character of your income for federal income tax purposes.
Ordinary income may be preferable for tax reasons
Although capital gains tax rates are much more favorable than ordinary income tax rates, there are three instances when you might prefer ordinary income:
- When you have unused ordinary losses or deductions: Allowable deductions and losses reduce your taxable income.
Say you have $100 of income this year and also have $100 of student loan interest. You have no other deductions, so your gross income equals $100. Your adjusted gross income (AGI), however, is $0. This is what is meant when it is stated that ordinary losses and deductions reduce or offset your taxable income. If you did not have the student loan interest deduction, your AGI would equal $100. AGI is the base from which you determine your taxable income.
But what if you have more deductions than income?
Assume you have $100 of income this year and $200 of student loan interest. You have no other deductions, so your gross income would equal $100 and your AGI would be $0. However, you would have an unused $100 loss. Now assume that you also bought bonds that produced $100 in interest. You can use your loss to offset the interest income from the bonds. Thus, your current AGI would be $0 despite the interest payment. In this case, you have accelerated your income in order to take advantage of an existing loss.
With one limited exception, you generally must match your ordinary deductions and losses to ordinary income.
- When you have unused capital losses: As we just discussed, you generally must match your ordinary income to ordinary losses and deductions. The matching principle also applies to capital gain and loss. There is one exception, however. If you have a net capital loss and do not have any unused ordinary losses, you are permitted to reduce ordinary income by $3,000 ($1,500 if married filing separately) of your net capital loss. So, when you have net capital losses, you may want to consider accelerating the recognition of ordinary income to take advantage of the availability of this loss.
- When the ordinary income is passive and you have passive losses: The passive-activity loss rules apply to your loss derived from investments in a passive activity. Generally speaking, a passive activity is any investment in a business in which you participate less than 500 hours per year. The passive-loss rule states that losses from your passive activity may be used only to reduce income from passive activities. Therefore, if you have passive losses, you may want to accelerate passive income.