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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
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.
How do I know if my dividends are qualified or ordinary? ›
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 do you avoid tax on qualified dividends? ›
You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.
What is an example of an ordinary dividend? ›
As a hypothetical example, consider the fictitious Joe Investor. He has 100,000 shares of Company ABC stock, which pays a dividend of $0.20 per year. In total, Joe Investor receives 100,000 x $0.20 = $20,000 per year paid in dividends from Company ABC.
What is the difference between qualified dividends and dividend distributions? ›
They're paid out of the earnings and profits of the corporation. Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates.
What makes an ordinary dividend qualified? ›
So, to qualify, you must hold the shares for more than 60 days during the 121-day period that starts 60 days before the ex-dividend date. If that makes your head spin, just think of it like this: If you've held the stock for a few months, you're likely getting the qualified rate.
Why are my dividends both ordinary and qualified? ›
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.
What does the IRS consider a qualified dividend? ›
To qualify for the qualified dividend rate, the payee must own the stock for a long enough time, generally 60 days for common stock and 90 days for preferred stock. To qualify for the qualified dividend rate, the dividend must also be paid by a corporation in the U.S. or with certain ties to the U.S.
At what income level are qualified dividends taxed? ›
Your “qualified” dividends may be taxed at 0% if your taxable income falls below $44,625 (if single or Married Filing Separately), $59,750 (if Head of Household), or $89,250 (if (Married Filing Jointly or qualifying widow/widower) (tax year 2023). Above those thresholds, the qualified dividend tax rate is 15%.
What is the 45 day rule for dividends? ›
The 45-Day Rule requires resident taxpayers to hold shares at risk for at least 45 days (90 days for preference shares, not including the day of acquisition or disposal) in order to be entitled to Franking Credits.
The tax rates for ordinary dividends are the same as standard federal income tax rates; 10% to 37%.
Are qualified dividends included in ordinary dividends on 1040? ›
Key Takeaways
Ordinary dividends, for tax purposes, includes both qualified and non-qualified dividends received. Generally, dividends of common stocks bought on U.S. exchanges and held by the investor for at least 60 days are "qualified" for the lower rate.
Are reinvested dividends taxable? ›
Dividends from stocks or funds are taxable income, whether you receive them or reinvest them. Qualified dividends are taxed at lower capital gains rates; unqualified dividends as ordinary income. Putting dividend-paying stocks in tax-advantaged accounts can help you avoid or delay the taxes due.
Can an LLC pay a qualified dividend? ›
LLC members may also receive a dividend (or a “distribution,” as it is generally referred to in the statutes). However, members have to approve the issuance of dividends, unless their operating agreement denies them the right.
How to tell difference between qualified and non qualified dividends? ›
How do I know if my dividends are qualified or not? You will receive an IRS form 1099-DIV from the company or your custodian at the end of the year. Qualified dividends would be shown in Box 1b whereas ordinary dividends would be in shown in box 1a.
Do qualified dividends affect your tax bracket? ›
Qualified dividends are taxed at capital gain rates of 0%, 15%, or 20%, depending on your tax bracket. If you are: In the 10% or 12% tax bracket, your qualified dividends are taxed at 0%, In the 22%, 24%, 32%, or 35% tax bracket, your qualified dividends are taxed at 15%, and.
Where do I find my qualified 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.
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 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.
