What is it:
Ordinary income is income taxed at your marginal tax rate, the same graduated rate schedule that applies to wages and salary, as opposed to the lower, preferential rates that apply to long-term capital gains. Most forms of executive compensation, including salary, bonus, and RSU or PSU value at vest, are classified as ordinary income.
Why does it matter:
Additional compensation that qualifies as ordinary income is added on top of your salary and bonus when determining which tax bracket applies. This means that a large equity vest can push you into a higher marginal rate. Understanding which components of your compensation qualify as ordinary income allows you to calculate the actual rate you're facing, thus reducing the risk of a surprise at tax time.
What do people most often get wrong:
People often assume equity compensation, because it's "stock," qualifies for the lower capital gains rates that apply to long-term investments. When your RSUs or PSUs vest, they are taxed as ordinary income. If you sell the shares at a price higher than the price when they vested, capital gains treatment applies to whatever additional appreciation happens after that value has already been taxed.