How Each Type of Income Is Taxed

Two households with the same income can owe very different amounts of tax, because the tax code does not treat every dollar alike. A dollar of salary, a dollar of bank interest, a dollar of stock dividends and a dollar of profit from selling shares you held for years can each be taxed at a different rate, and some income is not taxed at all. This chapter sorts income into its main types, shows the rate each one faces in 2026, and explains the add-on taxes that apply at higher incomes. Knowing the type is the first step to holding, timing and earning income in a way that keeps more of it.

Ordinary income: the default

Unless the law gives it special treatment, income is ordinary income and is taxed at the bracket rates from chapter 1. That covers most of what people earn:

• wages, salaries, bonuses, commissions and tips
• profit from self-employment or a business you run
• interest from bank accounts, CDs, bonds and Treasury securities
• dividends that are not "qualified" (see below), including most money market and REIT dividends
• short-term capital gains, from selling something you held for one year or less
• withdrawals from traditional 401(k)s and IRAs
• net rental income, unemployment benefits and most other income

Income you earn by working also carries payroll taxes. An employee pays 6.2% for Social Security and 1.45% for Medicare, and someone who is self-employed pays both halves, a total of 15.3%, which chapter 5 explains. Investment income does not carry payroll taxes. That is one reason the same dollar of income can cost very different amounts depending on how it was earned.

Long-term gains and qualified dividends: the lower schedule

Two kinds of investment income are taxed on a separate, lower schedule of 0%, 15% and 20%.

Long-term capital gains are profits from selling an asset, such as shares or a fund, that you owned for more than one year. Sell one day too early and the gain is short-term, taxed as ordinary income.

Qualified dividends are most dividends from US companies and many foreign ones, as long as you held the shares for more than 60 days in the 121-day period around the dividend date. Your brokerage's Form 1099-DIV shows which dividends qualified.

The rate depends on your total taxable income, with these gains counted on top of your ordinary income. For 2026 the 0% rate applies up to $49,450 of taxable income for a single filer and $98,900 for a couple filing jointly. The 15% rate applies above that up to $545,500 (single) and $613,700 (joint), and 20% above. A few kinds of gain have their own rates, such as collectibles, taxed at up to 28%.

The 0% band is more useful than many people expect.

A single filer with $60,000 of wages has taxable income of $43,900 after the standard deduction. That is below the $49,450 top of the 0% band, so long-term gains or qualified dividends that fill the gap are taxed at 0% federally. Gains beyond the gap are taxed at 15%. Someone with a modest income, or in a low-income year such as early retirement, can sell appreciated investments and reset their cost basis at no federal tax.

For someone with a higher income, the gap between the two schedules is the point.

At $85,000 of wages this filer's top bracket is 22.0%. One more dollar of bank interest or short-term gain would cost 22 cents in federal income tax; one more dollar of qualified dividends or long-term gain costs 15 cents.

Losses help too. Capital losses first offset capital gains; if losses are larger, up to $3,000 a year can be deducted from other income, and the rest carries forward to future years.

Income that is not taxed, or only partly taxed

Some income is excluded from federal income tax altogether, or taxed only in part:

• Municipal bond interest is free of federal income tax, and usually of state tax if the bond was issued in your own state.
• Qualified Roth withdrawals are tax-free, including the growth.
• Health savings account withdrawals for qualified medical costs are tax-free.
• Gifts and inheritances are not income to the person who receives them. Inherited investments generally get a new cost basis equal to their value at death, so the growth during the original owner's life is never taxed as a gain.
• Life insurance paid on a death is generally not taxable to the beneficiary.
• Gain on selling your main home is excluded up to $250,000, or $500,000 for a married couple filing jointly, if you owned and lived in it for at least two of the five years before the sale.
• Social Security benefits are taxed in part, depending on your other income: none, up to 50% or up to 85% of the benefit can be taxable.

The add-on taxes at higher incomes

Two surtaxes sit on top of the brackets. Neither of their income thresholds rises with inflation, so each year they reach more households.

The net investment income tax is 3.8% on interest, dividends, capital gains, rents and other investment income. It applies to the smaller of your net investment income and the amount by which your modified adjusted gross income exceeds $200,000 (single or head of household) or $250,000 (married filing jointly). For someone above those lines, the top federal rate on long-term gains is effectively 23.8%, not 20%.

The Additional Medicare Tax is 0.9% on wages and self-employment income above $200,000 for a single filer or $250,000 for a couple filing jointly. Employers start withholding it once your pay from them passes the single threshold, whatever your filing status, so a two-earner couple may owe more on the return and a couple where one spouse earns all the income may have too much withheld.

Rentals and other passive income

Rental income is ordinary income, but it is taxed on the net: rent minus mortgage interest, property tax, insurance, repairs and depreciation. Depreciation often makes a profitable rental show a small taxable profit or a loss. Losses from passive activities like rentals can generally offset only passive income, with an exception for people who actively manage their rentals and whose income is below a phase-out range. Depreciation claimed over the years is taxed when the property is sold, so the deduction is partly a deferral rather than a permanent saving. IRS Publication 527 sets out the rules for residential rentals.

Putting the types to work

Because the rate depends on the type, where you hold an investment can matter as much as what you hold. This is often called asset location.

• Investments that produce ordinary income, such as bond funds and REITs, are often held in traditional or Roth retirement accounts, where the yearly income is not taxed.
• Broad stock funds that pay mostly qualified dividends and grow through long-term gains are often held in taxable accounts, where they already get the lower rates.
• Municipal bonds make most sense in high brackets. To compare one with a taxable bond, divide the municipal yield by one minus your marginal rate: at a 24% rate, a 3% municipal yield matches a taxable yield of about 3.9%.
• Holding an investment for more than one year before selling turns an ordinary-rate gain into a lower-rate one.

None of these rules matter more than the investment itself. A good investment taxed at a higher rate can still beat a poor one taxed at a lower rate.