Dividends received from investments can be taxed differently. The IRS categorizes all dividends into 2 groups: qualified and nonqualified (ordinary). IRS qualified dividends are taxed at long-term capital gains tax rates which are significantly lower. This can relieve you of some tax expenses. However, these dividends must fulfill certain IRS criteria to be taxed at these lower rates.
Definition of IRS Qualified Dividends
A qualified dividend is one that meets the IRS’s criteria for favorable tax treatment. Unlike ordinary dividends, which are taxed as regular income, qualified dividends are taxed at 0%, 15%, or 20%, depending on your total taxable income and filing status. This lower rate rewards long-term investors and encourages holding stocks for extended periods.
IRS Requirements for a Dividend to Be Qualified
To qualify for the reduced tax rate, a dividend must meet three main conditions:
- It Must Be Paid by a U.S. or Qualified Foreign Corporation
- The dividend must come from a U.S. corporation or a qualified foreign corporation.
- A “qualified foreign corporation” is one that either:
- Trades on a U.S. stock exchange, or
- Is incorporated in a country that has a tax treaty with the United States.
- It Must Not Be Listed as an Unqualified Dividend Type
- Some dividends automatically fail to qualify regardless of where they come from.
- Examples include dividends from real estate investment trusts (REITs), master limited partnerships (MLPs), money market funds, and tax-exempt organizations.
- You Must Meet the Holding Period Requirement
- You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the stock’s ex-dividend date (the date after which new buyers do not receive the next dividend).
- For preferred stock, the holding period is more than 90 days during a 181-day period if the dividends relate to periods of more than 366 days.
Why Qualification Matters
Meeting the IRS qualifications for dividends can lead to substantial tax savings. For example, if your income places you in the 15% long-term capital gains bracket, a $5,000 qualified dividend would only generate $750 in taxes—compared to as much as $1,850 if it were taxed as ordinary income.
Confirm your dividends qualify—schedule a free consultation and get your 0%/15%/20% bracket estimate.