What is ordinary income?
Ordinary income refers to earnings subject to regular income tax rates, including wages, salaries, tips, bonuses, and business profits. Unlike capital gains, which are taxed at different rates, ordinary income is taxed based on the IRS’s progressive tax brackets.
For small business owners, understanding ordinary income helps employers properly withhold payroll taxes and ensure compliance with tax laws.
Which types of earnings are considered ordinary income?
Ordinary income includes various forms of earned and unearned income, such as:
- Employee wages and salaries: Payments made to workers for services rendered.
- Bonuses and commissions: Extra compensation earned by employees.
- Business income: Profits from sole proprietorships, partnerships, and S corporations.
- Self-employment earnings: Income from freelancers, gig workers, and independent contractors.
- Tips and gratuities: Income received by employees in tipped industries.
- Interest income: Earnings from savings accounts, bonds, and other investments (unless classified as capital gains).
- Rental income: If the business primarily engages in real estate activities, earnings may be taxed as ordinary income.
How is ordinary income taxed?
Ordinary income is subject to:
- Federal income tax: Based on the IRS tax brackets, which adjust annually.
- State and local income tax: Varies by state and city regulations.
- Payroll taxes (FICA): Includes Social Security and Medicare tax deductions for employees.
- Self-employment tax: Applies to freelancers and small business owners.
Ordinary income vs. capital gains
Ordinary income is taxed differently from capital gains. Here’s a comparison:
What does ordinary income mean for payroll?
Employers must account for ordinary income in payroll processing by:
- Withholding the correct income taxes from employee paychecks
- Calculating payroll tax deductions for Social Security and Medicare
- Tracking taxable compensation such as bonuses and overtime
- Ensuring compliance with federal and state tax laws
Manually tracking these items can result in costly errors. Luckily, businesses can automate these calculations and prevent payroll tax mistakes using payroll software.
How Homebase helps with ordinary income taxation
Handling payroll taxes and tax reporting manually can be complex, but Homebase payroll makes it easier by:
- Automatically calculating tax withholdings for ordinary income
- Ensuring compliance with IRS tax rates and state tax laws
- Providing detailed payroll reports for tax filing and employee earnings
- Helping businesses track payroll tax payments to avoid penalties
Get started with Homebase to simplify payroll, tax compliance, and wage management. Sign up today and ensure your business stays on top of tax reporting.