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When it comes to investing in stocks or other securities that pay out dividends, there are two types of dividends you may receive: ordinary dividends and qualified dividends. Qualified dividends receive favorable tax treatment and are taxed at a lower capital gains rate than ordinary dividends. What makes a dividend qualified depends on how long you hold onto the security, along with other criteria established by the IRS.
Here’s an overview of dividends, how each type of dividend works and what that means for your taxes.
What are dividends?
Let’s start with the basics: a dividend is a portion of a company’s earnings that’s distributed to shareholders. These earnings are usually paid out on a regular basis, such as quarterly, monthly or annually, and can be in the form of cash or additional shares of stock.
Ordinary Dividends
Ordinary dividends are called ordinary because they are taxed as ordinary income, which means your regular income tax rate. For some, this can mean as high as 37 percent for federal income tax if you’re in the highest tax bracket.
Qualified Dividends
Qualified dividends are taxed at a lower rate, generally the long-term capital gains tax rate. The long-term capital gains rate ranges from 0 percent up to 20 depending on your taxable income.
Here’s a quick breakdown of the long-term capital gains tax rates for 2023:
Taxable income
If your taxable income is below $41,675 for single filers or $83,350 married filing jointly, some or all of your net capital gain tax may be taxed at 0 percent. If your taxable income is $41,676 up to $459,750 for single filers or up to $517,200 for married filers, your tax rate 15 percent. If your taxable income exceeds $459,750 for single filers or $517,200 for married filers, a 20 percent rate applies to the excess.
In order for a dividend to qualify for a lower tax rate, it must meet certain criteria set by the IRS. The most important is the dividend must have been paid by a U.S. corporation or a qualifying foreign corporation, and the investor must have held the stock for a minimum amount of time, typically 61 days for common stock and 91 days for preferred stock.
Qualified dividends criteria
Here’s an overview of what makes a dividend qualified:
- The dividends were received from domestic or qualified foreign corporations.
- The stock or mutual fund share was held for the required holding period.
- The investment is not a real estate investment (REIT), master limited partnership (MLP), employee stock option, tax-exempt company or listed with the IRS as an investment that doesn’t qualify.
- The asset was not hedged, which means calls and puts or other derivatives weren’t used.
For more details and the latest guidance, check the IRS website and publications or a tax professional as these criteria may change.
How will I know if my dividends are qualified or ordinary?
You can find out whether your dividends are qualified or ordinary on the IRS Form 1099-DIV that your broker or trading platform sends you each year. It will have ordinary dividends listed in box 1a and qualified dividends in box 1b.
However, if you’re hoping to find that information per dividend stock, you’ll have to chat with your broker, or read through the IRS list for what makes a dividend qualified to see if the investment meets the requirements. For investors with portfolios that include foreign companies or alternative investments, it will be a little trickier than an investor who focuses on U.S. common stocks. Most major U.S. common stocks will likely count as qualified, as long as you meet the holding period requirement.
Why are qualified dividends taxed differently?
The idea behind this tax policy is to encourage long-term investment in the stock market. By offering a lower tax rate on qualified dividends, the government hopes to incentivize investors to hold onto their investments for a longer period of time, which can be beneficial both for the individual investor and for the overall economy.
Bottom line
Let’s recap: the primary difference between ordinary dividends and qualified dividends is how they are taxed. Ordinary dividends are taxed as ordinary income at your regular tax rate, while qualified dividends are taxed at a lower rate, similar to the long-term capital gains tax rate. To qualify for the lower tax rate on qualified dividends, the dividends must meet certain criteria set by the IRS. If you’re still unsure if your dividend yielding investments are qualified or ordinary, consult a financial professional for further clarification and advice.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
FAQs
Ordinary dividends are taxed as ordinary income at your regular tax rate, while qualified dividends are taxed at a lower rate, similar to the long-term capital gains tax rate. To qualify for the lower tax rate on qualified dividends, the dividends must meet certain criteria set by the IRS.
Do I claim ordinary dividends or qualified dividends? ›
Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates. The payer of the dividend is required to correctly identify each type and amount of dividend for you when reporting them on your Form 1099-DIV for tax purposes.
How do I know if a dividend is qualified or unqualified? ›
A dividend is considered qualified if the shareholder has held a stock for more than 60 days in the 121-day period that began 60 days before the ex-dividend date.2 The ex-dividend date is one market day before the dividend's record date.
How to estimate qualified dividends? ›
Calculating the amount of qualified dividends
Once you determine the number of shares that meet the holding period requirement, find the portion per share of any qualified dividends. For each qualified dividend, multiply the two amounts to determine the amount of the actual qualified dividend.
Are qualified dividends taxed at the same rate as ordinary income True or false? ›
Qualified dividends are taxed at the same rates as the capital gains tax rate, which is lower than ordinary income tax rates. The tax rates for ordinary dividends are the same as standard federal income tax rates; 10% to 37%.
Do you combine qualified and ordinary dividends? ›
Qualified dividends are a subset of your ordinary dividends. Qualified dividends are taxed at the same tax rate that applies to net long-term capital gains, while non-qualified dividends are taxed at ordinary income rates. It is possible that all of your ordinary dividends are also qualified dividends.
How much dividend income is tax free? ›
Qualified Dividend Taxes
| Dividend Tax Rate, 2022 |
|---|
| Filing Status | 0% Tax Rate | 20% Tax Rate |
|---|
| Single | $0 to $41,675 | $459,751 or more |
| Married Filing Jointly | $0 to $83,350 | $517,201 or more |
| Married Filing Separately | $0 to $41,675 | $258,601 or more |
1 more rowDividend Tax Credit for Eligible & Non-eligible Dividends
The type of dividends depends on the status of the corporation: Eligible Dividends: The corporation has to designate the dividends as “eligible” which means that they paid higher tax rates. In return, you will pay more taxes and receive a higher tax credit.
Why are all my dividends non-qualified? ›
A nonqualified dividend is one that doesn't meet IRS requirements to qualify for a lower tax rate. These dividends are also known as ordinary dividends because they get taxed as ordinary income by the IRS. Nonqualified dividends include: Dividends paid by certain foreign companies may or may not be qualified.
Can non-qualified dividends be reinvested? ›
Reinvested dividends may be treated in different ways, however. Qualified dividends get taxed as capital gains, while non-qualified dividends get taxed as ordinary income. You can avoid paying taxes on reinvested dividends in the year you earn them by holding dividend stocks in a tax-deferred retirement plan.
It asks about qualified dividends. If you have those, you'll need to fill out the Qualified Dividends and Capital Gains Tax Worksheet next. Otherwise, you're done with Schedule D, and you'll be paying ordinary income taxes on everything on line 7 because those are short-term gains.
What is the formula for calculating dividend income? ›
To calculate how much you'll receive, multiply the dividend yield by the stock's par value and then multiply that amount by the number of shares that you own. For instance, if you own ten shares of preferred stock with a par value of $50 per share and a 10% yield, the dividend payment will be $50.00.
What is the maximum tax rate for qualified dividends? ›
Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%. IRS form 1099-DIV helps taxpayers to accurately report dividend income.
Do I report qualified or ordinary dividends? ›
Qualified dividends are all or a portion of the total ordinary dividends. They're reported in box 1a on Form 1099-DIV. While this sounds complicated, your financial institution should specify which dividends are qualified when they report your dividends to you on Form 1099-DIV. Qualified dividends appear in box 1b.
What determines if a dividend is qualified or ordinary? ›
Let's recap: the primary difference between ordinary dividends and qualified dividends is how they are taxed. Ordinary dividends are taxed as ordinary income at your regular tax rate, while qualified dividends are taxed at a lower rate, similar to the long-term capital gains tax rate.
How do you avoid tax on qualified dividends? ›
Strategies such as contributions to retirement accounts and health savings accounts (HSAs) may reduce your income below the zero-capital gains tax threshold. As a result, you wouldn't owe any taxes on qualified dividends.
Are dividends taxed when declared or paid? ›
Investors pay taxes on the dividend the year it is announced, not the year they are paid the dividend.
Are dividends taxed if reinvested? ›
The IRS considers any dividends you receive as taxable income, whether you reinvest them or not. When you reinvest dividends, for tax purposes you are essentially receiving the dividend and then using it to purchase more shares.
What is the tax treatment of dividend income? ›
However, under section 194 of the Income-tax Act of 1961, the firm declaring the dividend will have to deduct TDS. According to this provision, dividend income beyond Rs. 5000 for an individual is subject to 10% TDS; if the beneficiary of the dividend does not submit a PAN, this rate will increase to 20%.
Are qualified dividends reported on Schedule B? ›
Enter the amount of qualified dividends you received on line 5 of Schedule B. Enter the amount of ordinary dividends you received on line 6 of Schedule B. Add the amounts on lines 1, 5, and 6. If the total is over $1,500, you must complete Part III of Schedule B.
