Ordinary dividends are payments a public company makes to owners of its common stock shares. It is their share of the company's profits and a reward for holding onto the shares. A qualified dividend is an ordinary dividend that can be reported to the IRS as a capital gain rather than income.
For some but not all taxpayers, that is a significant saving in taxes owed on the dividends. Individuals earning over $41,675 ($83,350 if married and filing jointly) pay at least a 15% tax on capital gains as of the 2023 tax year. If you earn less than that, you don't pay taxes on capital gains—you only pay income taxes.
Key Takeaways
- A qualified dividend is an ordinary dividend that meets the criteria to be taxed at capital gains tax rates, which are lower than income tax rates for some taxpayers.
- Qualified dividends must meet special requirements issued by the IRS.
- The maximum tax rate for qualified dividends is 20%, with a few exceptions for real estate, art, or small business stock. Ordinary dividends are taxed at income tax rates, which as of the 2023 tax year, maxes out at 37%.
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Understanding Qualified Dividends
Dividends are separated into two classes by the IRS, ordinary and qualified. A dividend is considered to be qualified if you have held a stock for more than 60 days in the 121-day period that began 60 days before the ex-dividend date. It is an ordinary dividend if you hold it for less than that amount of time.
The ex-dividend date is one market day before the dividend's record date. The record date is the date at which a shareholder must be on the company's books to receive the dividend.
For example, imagine you owned XYZ stock, which declared a dividend payment on Nov. 20 and set a record date for a month later, with an ex-dividend date of Dec. 19.
If you bought XYZ stock before Dec. 19 and held it for at least 61 days in the 121-day period that began 60 days before the ex-dividend date, you'd pay the capital gains tax rate on the dividend.
If you bought XYZ stock before Dec. 19 and received a dividend, but did not hold it for the required 61 days, it would be counted as ordinary income on your tax return for that year.
The ex-dividend date is key. You'll be eligible to receive the next dividend if you purchase stock before the ex-dividend date. You won't receive the next dividend if you purchase it on or after the ex-dividend date.
Capital gains are currently taxed at a rate of 0%, 15%, or 20%, depending on the taxpayer's income. If you have capital gains from selling collectibles or a qualified small business stock, you might pay up to 28%. Unrecaptured gains from selling section 1250 real property is taxed at up to 25%. So, most investors pay zero or 15%, with only the highest earners paying the 20% rate.
There are several other requirements for qualified dividends:
- The dividend must have been paid by a U.S.company or a qualifying foreign company.
- The dividends are not listed with the IRS as those that do not qualify.
- The required dividend holding period has been met.
Where to find qualified dividends
IRS Form 1099-DIV, Box 1a, Ordinary Dividends sent from your broker shows all your dividends. Qualified dividends are listed in Box 1b on form 1099-DIV and are the portion of ordinary dividends from Box 1a that meet the criteria to be treated as qualified dividends.
Qualified Dividend Tax Treatment
Qualified and ordinary dividends have different tax implications that impact your netreturn. The tax rate is 0% on qualified dividends if your taxable income is less than $41,675 for singles and $83,350 for joint married filers.
If you make more than $41,675 (single) or $83,350 (joint), you'll have a 15% tax rate on qualified dividends. If your income exceeds $459,750 for a single person or $517,200 for a married couple, your capital gains tax rate will be 20%.
Note that there is an additional 3.8% Net Investment Income Tax (NIIT) on investment gains or income. The IRS uses the lowest figure of your net investment income or the excess of your modified adjusted gross income (MAGI) that exceeds $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately to determine this tax.
So, to incur the NIIT, your MAGI must exceed the previously listed thresholds.
Other Qualifying Dividend Requirements
Foreign companies
A foreign corporation qualifies for the special tax treatmentif it meets one of the following three conditions: the company is incorporated in a U.S. possession, the corporation is eligible for the benefits of a comprehensive income tax treaty with the United States,or the stock is readily tradable on an established securities market in the United States. A foreign corporation is not qualified if it is considered a passive foreign investment company.
Dividends that do not qualify
Some dividends are automatically exempt from consideration as qualified dividends. These include dividends paid by real estate investment trusts (REITs), master limited partnerships (MLPs), employee stock options, and those on tax-exempt companies.
In addition, dividends paid from money market accounts, such as deposits in savings banks, credit unions, or other financial institutions, do not qualify and should be reported as interest income.
Special one-time dividends are also unqualified.
Finally, qualified dividends must come from shares not associated with hedging, such as those used for short sales, puts, and call options.These investments and distributions are subject to the ordinary income tax rate.
Holding periods for other investments
Preferred stocks have a different holding period than common stocks. You have to hold preferred stock for more than 90 days during a 181-day period that starts 90 days before the ex-dividend date.
The holding period requirements are somewhat different for mutual funds. The mutual fund itself must have held the security unhedged for at least 60 days of the 121-day period, which began at least 60 days before the security's ex-dividend date. To receive capital gains tax treatment in your mutual fund, you must have held the applicable share of the mutual fund for the same period.
What It Means for Investors
Most regular dividends from U.S. corporations are considered qualified. The question of whether you have qualified dividends or not can arise if you focus on foreign companies, REITs, MLPs, or tax-exempt companies.
If you don't stray from the big names in common stocks, you need only be careful to hold onto the shares long enough to qualify for the dividend payments.
Why Are Qualified Dividends Taxed More Favorably Than Ordinary Dividends?
The favorable tax treatment for qualified dividends is intended to give companies an incentive to regularly use a share of their profits to reward their shareholders. It also gives investors a reason to hold onto their stocks long enough to earn dividends.
What Are the Requirements for a Dividend to Be Considered Qualified?
Stock shares that pay dividends must be held for at least 61 days within a 121-day period that begins 60 days before the ex-dividend date.
How Do I Know If the Dividends I've Received Are Qualified or Not?
The online trading platform or broker you use will break down the qualified and ordinary dividends paid to you in separate boxes on the IRS Form 1099-DIV sent to you for the year. Ordinary dividends are reported in box 1a, and qualified dividends in box 1b.
The Bottom Line
For most individual investors, qualified dividends offer the chance of a tax break. The dividends of most American companies are qualified dividends. The investor's only concern should be to qualify for the lower capital gains tax rate by purchasing shares before the ex-dividend date and holding them for more than 60 days.
Correction—Nov. 28, 2023: This article has been corrected to state that a shareholder must buy a stock before the ex-dividend date and hold it for more than 60 days during a certain period in order for the dividend to be qualified.
