Investors really value the passive income that dividends bring. However, dividends are not all the same when it comes to the taxes that are imposed — qualified and nonqualified (ordinary). The taxes that investors are charged are influenced by the dividends the IRS classifies. Understanding this allows investors to plan and retain more of their income.
What Are Qualified Dividends?
Qualified dividends are taxed at lower long-term capital gains tax rates like 0%, 15%, or 20% based on your income. This is usually lower than the tax rates on your salary or business income.
To be considered a qualified dividend the dividend must meet the 3 following conditions:
- It must be paid by a U.S. corporation or a qualified foreign corporation (a foreign corporation that trades on a U.S. exchange or has a U.S. tax treaty with the U.S.).
- It must not be classified by the IRS as a disqualified dividend (for instance dividends paid by REITs, MLPs, or tax-exempt organizations).
- The stock has to be held long enough to meet the ‘holding period’ requirement which is more than 60 days in the 121-day period that begins 60 days before the stock’s ex-dividend date.
Meeting these conditions means that you can benefit from the lower capital gains tax which is a huge advantage for long-term investors.
What Are Nonqualified Dividends?
Nonqualified dividends, also called ordinary dividends, are those that don’t meet the IRS criteria for qualified status. These dividends are taxed as ordinary income, meaning they’re subject to your regular income tax bracket—anywhere from 10% up to 37% for high earners.
Examples of nonqualified dividends include:
- Dividends from real estate investment trusts (REITs)
- Dividends from master limited partnerships (MLPs)
- Money market or mutual fund distributions that don’t meet the holding period rules
- Dividends paid by tax-exempt organizations or certain foreign corporations
Key Difference and Why It Matters
The main difference between qualified and nonqualified dividends lies in how they are taxed. Qualified dividends receive preferential treatment as an incentive for long-term investment, while nonqualified dividends are taxed more heavily.
In short, if you plan to hold stocks for more than a few months, qualifying for lower dividend tax rates can make a meaningful difference in your after-tax income.
Reach out to our dedicated team at Dimov Tax today to see if your dividends qualify for 0%, 15% or 20%.