Abstract: The purpose of this study is to examine rural poverty based on different household socio-economic variables. It also tries to highlight the source of inequality using decomposition of economic inequality indices in poverty ridden rural areas. A household survey was conducted from April to December, 2007 in Nabweya and Bufumbo parish, Mbale district. A total of 116 sample households from Nabweya 60 and Bufumbo parish 56 were randomly selected and interviewed using semi-structured questionnaires. The household level data were collected on various socio-economic aspects and focusing on different sources of income. The coefficient of variation and Gini-coefficient were used to measure the income inequality decomposition. The results show that based on tribe, the Iteso are deprived in terms of education and landholding and therefore, laboring and agriculture remain the prominent source of income for them. Average income from salaried job is the highest followed by remittance and that from laboring is the lowest. This led to the high concentration of Iteso under third and fourth income quartile (poorer). A share of income from agriculture in total income is the highest and the share from laboring is the lowest. Relative concentration coefficient shows salaried job has both the highest income disequalizing effect (C_j = 1.56 or g_i = 1.49) as well as the highest factor inequality weight followed by agriculture. In case of Bufumbo parish, however, salaried job followed by remittance has the highest income disequalizing effect. Negative values of Relative Concentration Coefficient and factor inequality weight for laboring indicate that income from it has the income equalizing effect. Thus, agricultural promotion in rural areas based on labor-demand increasing policies with proper market arrangements for the agricultural produce will be helpful to reduce the income inequality. In addition, regulation regarding minimal wage rate should be strictly enforced for the welfare of those involved in laboring, which is also the poorest.