In the realm of taxation, income and financial management there are two main types of income, namely ordinary income and capital gains. Incomes are categorized in this way to assist in several financial processes. Both ordinary income and capital gains include a wide array of money streams and are taxable at different rates. For this reason, a Form 1040 is a useful document to review when identifying the many types of income because naturally the Government doesn't want to leave anything out. However, what 1040's may not always make clear is the differentiation between the two types of income.

Capital gains are divided into short-term and long-term, the former of which can be taxed higher than the latter, i.e., a tax rate that matches the income tax bracket. As the name implies, capital gains are monetary gains acquired through the exchange of property, businesses and financial instruments requiring capital. Examples of capital gains include money acquired through the sale of homes, corporate acquisition, stocks and foreign exchange. In the case of mutual funds, the trading practices of the fund manager determine whether increases in value from owning the mutual fund are due to short-term or long-term investing on the part of the mutual fund.

Ordinary income can be thought of as every other type of income that is not a capital gain with a few exceptions. On a tax form the sources of income include wages, dividends, retirement distributions, rental income, self-employment income, farm income and social security benefits.

While income earned from the sale of stocks is considered a capital gain, dividend income received from stocks that pay dividends is considered ordinary income. Some dividends however, are also subject to lower taxes than short-term capital gains and can be taxed from anywhere between 5-15%. These latter dividends are kind of in an income class all their own because they are taxed differently than capital gains and ordinary income.

There are benefits and disadvantages associated with each type of income. Ordinary income tends to be more stable and consistent whereas capital gain income can be periodic and variable. What's more, both types of income are treated differently by different financial institutions.

In the case of capital gains, they are not always considered income by mortgage banks. Mortgage banks often use the 29% rule when calculating mortgage loan qualification. In doing so, the bank will take 29% of one's pre-taxed income as a starting point, i.e., ball park estimate of what a home buyer can afford. Capital gains are not included in this percentage calculation because of their status as non-ordinary income.

While It can be considered wise to have as many sources of income as possible to insure strong income flow from all directions, this may not always be a good choice. This is so because if an increase in one type of income pushes one into a higher tax bracket, that type of income may cost the earner of that income a bigger piece of effort, financial planning and money.

To restructure income so it is taxed the least and earns the most, various financial instruments such as IRA's, life insurance policies, bonds and mortgages can all be utilized to offset one's adjusted gross income and maximize one's retained income.

In summary, there are two types of income, capital gains and ordinary income and in special cases like qualified dividends, ordinary income with caveats. Capital gains are acquired through returns on capital investment generated through exchange whereas ordinary income is often earned, legally obliged or interest on capital investment. The two types of income have different qualities and are treated differently in financial markets and institutions. Structuring and management of these two types of income can lead to different results that either benefit a tax payer or cost a tax payer more money.