Qualified Dividends vs Ordinary Dividends
| Aspect | Qualified Dividends | Ordinary Dividends |
|---|---|---|
| Definition | Dividends that meet specific IRS criteria for favorable tax treatment. | Dividends that do not meet the criteria for qualified status. |
| Tax Rate | Taxed at the lower capital gains tax rates: 0%, 15%, or 20%, depending on income level. | Taxed at ordinary income tax rates, which can be as high as 37%. |
| Eligibility Criteria | – Must be from a U.S. corporation or qualified foreign corporation. – Shares held for more than 60 days during the 121-day period surrounding the ex-dividend date. | No holding period requirement. Includes dividends from tax-exempt corporations, capital gains distributions, and others excluded from qualified dividends. |
| Tax Forms | Reported as qualified dividends in Box 1b of IRS Form 1099-DIV. | Reported as ordinary dividends in Box 1a of IRS Form 1099-DIV. |
| Examples | Dividends from common stocks held long-term in U.S. companies. | Dividends from money market accounts, REITs, MLPs, and some foreign corporations. |
| Impact on Your Taxes | Results in significantly lower tax bills, saving investors thousands annually in most cases. | Taxed at normal income rates, leading to higher tax liabilities. |
Summary
- Qualified dividends enjoy special tax treatment to encourage long-term investment. They are taxed at capital gains rates, which are generally much lower than ordinary income tax rates.
- Ordinary dividends are taxed as regular income and can result in a higher tax bill.
- To receive the benefit of qualified dividend tax rates, investors must satisfy IRS requirements regarding the dividend source and how long they have held the shares.
Example
If you are in the 28% tax bracket:
- $20,000 in ordinary dividends would yield a tax of $5,600.
- The same amount in qualified dividends could be taxed at 15%, totaling $3,000, saving you $2,600 in taxes.
Knowing this difference can help investors plan their portfolios for tax efficiency and maximize after-tax returns. For personal advice, consult a tax professional.
Sources: IRS, Investopedia, Bankrate, Vanguard
