When a corporation has profits, a portion can be paid out to its shareholders in the form of a dividend. Dividends are taxable (except in a tax-advantaged account, like a retirement account) and the dividend tax rate is determined by an investor’s tax bracket and dividend type.
What is a Dividend Tax Rate?
A dividend tax rate is the rate at which the dividends that a company pays out to its shareholders in a given calendar year is subject to taxes during tax season. The rate differs based on circ*mstances of each investor like their income level, and based on the type of dividend the investor has received. In most cases, the higher the investor’s tax bracket, the higher the dividend tax rate.
Ordinary vs. Qualified Dividend Tax Rates
There are two types of dividends:
1. Qualified Dividends
Characteristics of qualified dividends include:
- They must come from a U.S. corporation or a qualifying foreign entity.
- Tax rates on are based on the capital gains tax rate.
- Tax rates are 0%, 15%, or 20%, depending on an investor's filing status.
2. Non-Qualified Dividends
Ordinary, or non-qualified, dividends:
- Are taxed based on the investor's federal income tax bracket
- Can have a tax rate up to 37%, depending on the investor's tax bracket.
Key Takeaway: Qualified dividends offer better tax treatment compared to nonqualified dividends.
2021 & 2022 Qualified Dividend Tax Rates
The following dividend tax rates are for qualified dividends. Investors should refer to their federal income tax bracket to determine their nonqualified dividend tax rate. The rates included, for reference, under "2021" refer to the rate paid by April 18, 2022 for the former tax year. The rates under "2022" is what applied to the 2022 calendar year for the April 2023 filing season.
Single Filers
Tax Rate 2022 Taxable Income Range 2021 Taxable Income Range 0% $0 to $41,675 15% $41,676 to $459,750 $40,401 to $445,850 20% $445,851 and up $459,751 and up
$0 to $40,400
Head of Household Filers
Tax Rate 2022 Taxable Income Range 2021 Taxable Income Range 0% $0 to $55,800 $0 to $54,100 15% $55,801 to $488,500 $54,101 to $473,750 20% $488,501 and up $473,751 and up
Married, Filing Jointly
Tax Rate 2022 Taxable Income Range 2021 Taxable Income Range 0% $0 to $83,350 $0 to $80,800 15% $83,351 to $517,200 20% $517,201 and up $501,601 and up
$80,801 to $501,600
Married, Filing Separately
Tax Rate 2022 Taxable Income Range 2021 Taxable Income Range 0% $0 to $41,675 $0 to $40,400 15% $41,676 to $258,600 $40,401 to $250,800 20% $258,601 and up $250,801 and up
How the Tax Rate on Dividends Works
How the dividend tax rate is calculated depends on the type of dividend received. Qualified dividends are taxed at capital gains rates. Ordinary (non-qualified) dividends are taxed based on ordinary income rates. Tax rates are influenced by taxable income, filing status, tax deductions, adjustments, and exemptions, and the amount owed may be offset by tax credits.
IRS Publication 550 lists the scenarios in which an investor's dividends receive special tax treatment. These include dividends received on restricted stock and dividends that aren't really dividends and are actually interest. These are monies received on deposits or share accounts from:
Cooperative banks
Credit unions
Domestic building and loan associations
Domestic savings and loan associations
Federal savings and loan associations
- Mutual savings banks
For investors falling in the lowest income brackets, their dividend tax burden is 0%. If an investor owes taxes on a dividend, the dividend tax rate is typically paid by the investor when taxes are filed. If a dividend is in a pre-tax retirement account, the dividends can grow tax-free until the investor retires. Similarly, a dividend paid to a cash value life insurance policyholder counts as a non-taxable distribution.
In order to receive a dividend, an investor must purchase a stock two business days before the date of record. A company declares the date of record when announcing the dividend, which typically happens on a quarterly basis. Whether these dividends are received in cash or reinvested into the same company, the dividends are taxable, unless received in a tax-sheltered account.
Key Takeaway: Some dividends received are actually interest and must be reported as such.
Tax Treatment of Qualified Dividends
Tax treatment on qualified dividends depends on the type of stock held by the investor receiving the dividend:
- Common stock: The security paying the dividend must be held by the investor for 60 days during the 121-day period prior to the ex-dividend date.
- Preferred stock: must be held for 90 days or more during the 121-day period prior to the ex-dividend date to be considered qualified.
Qualified dividends are taxed less than its nonqualified counterpart.
How Dividend Income Is Reported
Investors receive a 1099-DIV form from their brokerage firm so they may file taxes. This details data such as total ordinary dividends, qualified dividends, investment expenses, and total capital gain distributions. Firms are required to send the 1099-DIV by January 31 each year. However, investors with less than $10 to report will not receive one.
If an investor receives a dividend through a partnership or a beneficiary of an estate or trust, an investor will receive a Schedule K-1. A prospectus will detail a company's dividend policy so investors know what to expect at tax time. Investors can contact their brokerage firms if they're unsure which type of account they hold.
Strategies to Manage Dividend Taxes
There are a few strategies that investors can keep in mind to minimize the amount of yearly taxes they must pay on their dividends earned:
- Use Tax-Advantaged Accounts: Investors can reduce their dividend tax exposure by holding dividend-paying investments in tax-advantaged accounts, like a retirement account. These include 401ks, IRAs, and Roth IRAs.
- Invest In Stocks That Give Qualified Dividends: qualified dividends benefit from better tax treatment than nonqualified when in a taxable account. Nonqualified dividends can be taxed up to 37%, whereas qualified dividends have a 20% maximum tax rate.
Tip: Dividend income received in tax-advantaged accounts, such as a 401k or IRA, allow investors to defer taxation.
Net Investment Income Tax
Investors with high incomes may be subject to net investment income tax, which is 3.8% for the 2021 and 2022 calendar years, and is reported on Form 8960. The income threshold depends on an investor's filing status:
Filing Status Income Threshold Married filing jointly $250,000 Married filing separately $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $250,000
Bottom Line
Both qualified and nonqualified dividends are taxed unless received in a tax-advantaged account like a 401k or IRA. In the case of a tax-advantaged account, the investor doesn't have to pay taxes until retirement. Low-income investors benefit from 0% tax rates, and qualified dividends have special tax advantages compared to those that are nonqualified.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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