As a small business owner, you track the money your company earns in your accounting books. Can you identify the types of income you record? For example, ordinary income is a common type of income that your business earns.
What is ordinary income?
As a small business owner, you need to account for your company’s ordinary income. Ordinary business income includes any earnings your company makes through daily operations. Profit from selling a product or providing a service is ordinary business income.
For example, you sell $20,000 worth of products. You have $10,000 in the cost of goods sold (COGS) and $5,000 in operating expenses. Your ordinary business income is $5,000 ($20,000 – $10,000 – $5,000).
You need to keep track of your ordinary business income for tax purposes. It is important to track business income separately from personal income. A separate bank account for business helps you report only business income on company tax forms.
You use a different tax form to report ordinary income depending on your type of business structure:
- Sole proprietorships report using Schedule C.
- Partnerships report using Form 1065.
- Corporations report using Form 1120.
Business income can be positive or negative. If you have positive ordinary income, you are earning more than you are spending. If you have negative ordinary income, you are earning less than you are spending.
Ordinary income vs. capital gains
Often, businesses make two different types of income. Businesses can earn ordinary income and capital gains. Ordinary income and capital gains have several differences, including tax rates.
You earn ordinary business income when someone pays you for providing products or services. Ordinary income is taxed at the federal, state, and local tax rates.
You earn capital gains by investing in an asset and selling it for more than the original price. For example, you might buy a building and sell it later for a higher amount. The money you make from the sale is a capital gain.
Capital gains break down into short-term and long-term gains. You keep short-term capital gains for less than one year before selling them. Short-term capital gains are taxed at ordinary income rates. That means short-term capital gains and ordinary income are taxed the same.
On the other hand, you sell long-term capital gains over a year from the asset’s purchase date. Long-term capital gains are taxed at a much lower rate than ordinary business income.
You should consult a tax expert if you have long-term capital gains. The rules for capital gains taxation are complicated and change often.
A corporation is double taxed. That means the business is taxed when it earns a profit. Then, the business is taxed again when it distributes dividends to the owners.
Corporation owners are paid with dividends, or distributions of company profits. If you own a corporation, you 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.
Keeping up with your income doesn’t have to be complicated. Patriot’s online accounting software makes tracking income a breeze. And, we offer free, USA-based support. Try it for free today!
This article is updated from its original publication date of August 30, 2016.This is not intended as legal advice; for more information, please click here.