At some point in almost every investor's life, they'll be alerted to the fact that they're collecting "qualified dividends." That inevitably prompts the natural question: What are qualified dividends vs ordinary dividends?
Ultimately, the importance of this distinction has to do with how you're taxed on your dividends. The tax rate on qualified dividends is 15% for most taxpayers. (It's zero for single taxpayers with incomes under $44,625 and 20% for single taxpayers with incomes over $4492,301.) However, "ordinary dividends" (or "nonqualified dividends") are taxed at your normal marginal tax rate.
But on a more fundamental level: What exactly is a qualified dividend, and how do we know if the dividends paid by the stocks in our portfolios are qualified? And what investments pay out nonqualified dividends?
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Let's start by examining how qualified dividends were created in the first place. Then we'll explain how that affects the rules governing them and ordinary dividends today.
How qualified dividends came to be
The concept of qualified dividends began with the 2003 tax cuts signed into law by George W. Bush. Previously, all dividends were taxed at the taxpayer's normal marginal rate.
The lower qualified rate was designed to fix one of the great unintended consequences of the U.S. tax code. By taxing dividends at a higher rate, the IRS was incentivizing companies not to pay them. Instead, it incentivized them to do stock buybacks (which were untaxed) or simply hoard the cash.
By creating the lower qualified dividend tax rate that was equal to the long-term capital gains tax rate, the tax code instead incentivized companies to reward their long-term shareholders with higher dividends. It also incentivized investors to hold their stocks for longer to collect them.
The idea was to create a better kind of company and a better kind of investor.
It's debatable as to whether the lower rate had the desired effect; in the 17 years that have passed, companies (particularly in the tech sector) continue to hoard a lot of cash, and buybacks were credited with being one of the biggest drivers of the 2009-20 bull market.
But it's certainly true that dividends became more of a focus for both investors and the companies paying them following the 2003 tax reforms. Even tech darlings like Apple (AAPL) and Nvidia (NVDA) regularly pay dividends.
Qualified dividends vs ordinary dividends
To be a qualified dividend, the payout must be made by a U.S. company or a foreign company that trades in the U.S. or has a tax treaty with the U.S. That part is simple enough to understand.
The next requirement gets tricky.
The tax cut was designed to reward patient, long-term shareholders. 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. If you haven't, you're probably not, or at least not yet.
Certain types of stocks don't make the cut.
For example, real estate investment trusts (REITs) and master limited partnerships (MLPs) typically do not pay qualified dividends. REIT dividends and MLP distributions have more complicated tax rules; however, in some cases, they might actually have lower effective tax rates.
Money market funds and other "bond like" instruments generally pay ordinary dividends. So do dividends paid out via an employee stock-option plan.
The good news: It's actually not your problem to figure this out if you really don't want to. Your broker will specify whether the dividends you received are qualified or not in the 1099-Div they send you at tax season.
But knowing whether you're being paid qualified dividends can help you plan properly. Perhaps you can arrange your dividend stock portfolio such that your lower-taxed qualified dividends are paid into your taxable brokerage account and your higher-taxed ordinary dividends are paid into your IRA.
If all of this is making your head spin, we can summarize like this:
Most "normal" company stocks you've held for at least two months will have their dividends qualified. Many unorthodox stocks – such as REITs and MLPs – and stocks held for less than two months generally will not.
Also, while we summarized the tax basics above, here's a look at how qualified dividends are taxed for every situation for the 2023 tax year:
Swipe to scroll horizontally
| Status | Taxable income | Tax rate |
|---|
| Single | $0 to $44,625 | 0% |
| Row 1 - Cell 0 | $44,626 to $492,300 | 15% |
| Row 2 - Cell 0 | $492,301 or more | 20% |
| Married, filing jointly | $0 to $89,250 | 0% |
| Row 4 - Cell 0 | $89,251 to $553,850 | 15% |
| Row 5 - Cell 0 | $553,851 or more | 20% |
| Head of household | $0 to $59,750 | 0% |
| Row 7 - Cell 0 | $59,751 to $523,050 | 15% |
| Row 8 - Cell 0 | $523,051 or more | 20% |
| Married, filing separately | $0 to $44,625 | 0% |
| Row 10 - Cell 0 | $44,626 to $276,900 | 15% |
| Row 11 - Cell 0 | $276,901 or more | 20% |
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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.
How do you know if a dividend is ordinary or qualified? ›
How Do Investors Know If the Dividends I've Received Are Qualified or Not? The online trading platform or broker that an investor employs will break down the qualified and ordinary dividends paid in separate boxes on the IRS Form 1099-DIV. Ordinary dividends are reported in box 1a, and qualified dividends in box 1b.
What are the requirements for qualified dividends? ›
You must have held those shares of stock unhedged for at least 61 days out of the 121-day period that began 60 days before the ex-dividend date. For certain preferred stock, the security must be held for 91 days out of the 181-day period beginning 90 days before the ex-dividend date.
How do you avoid tax on qualified dividends? ›
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).
Do I subtract qualified dividends from 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.
Do I pay taxes on 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.
How do I know if my ETF has qualified dividends? ›
Qualified. To receive a qualified dividend, you must hold an ETF for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date and ends 60 days after that date. This is the last day when new owners can qualify for the next dividend.
Why would a dividend not be 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.
What is a qualified dividend in Canada? ›
An eligible dividend is any taxable dividend paid to a resident of Canada by a Canadian corporation that is designated by that corporation to be an eligible dividend. A corporation's capacity to pay eligible dividends depends mostly on its status.
Do I have to claim 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.
AMT starts when the dividends reach $55,002 (2022 $54,403). Federal AMT is applicable for dividends above this amount, until the amount of the dividends reaches $175,218 (2022 $161,215), when the regular federal tax equals or exceeds the minimum amount.
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.
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 rowQualified dividends are taxed at capital gains rates rather than ordinary income-tax rates, which are higher for most taxpayers. If the payment is not classified as a qualified dividend, it is a non-qualified dividend. Ordinary dividends, for tax purposes, includes both qualified and non-qualified dividends received.
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.
Do qualified dividends count as gross income? ›
Key Takeaways. All dividends paid to shareholders must be included on their gross income, but qualified dividends will get more favorable tax treatment.
What is considered an ordinary dividend? ›
Ordinary, or non-qualified, dividends are paid by corporations to shareholders of record. Dividends are considered ordinary by default unless they meet special requirements put in place by the IRS. Ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at the lower capital gains rate.
What is the difference between eligible and non eligible dividends in Canada? ›
Eligible dividends are taxed more favourably than non-eligible dividends because the corporation has paid tax at higher rates and the individual receiving the dividend pays less. Dividends are taxed at lesser rates than employment income and many other types of income in your hands personally.
What qualifies as ordinary income? ›
Ordinary income is any income taxable at marginal rates. Examples of ordinary income include salaries, tips, bonuses, commissions, rents, royalties, short-term capital gains, unqualified dividends, and interest income.
Are money market dividends qualified dividends? ›
Qualified dividends are taxed at a lower rate than ordinary dividends. Most regular dividends from U.S. companies are considered qualified. Dividends from REITs, master limited partnerships and money market accounts are not considered qualified (more detailed list below).
