What Are Qualified Dividends for Tax Purposes

Like other income and capital gains on investments, dividend income is effectively taxable. However, the dividend tax rate depends on a number of factors, including your taxable income, the type of dividend and the type of account holding the investment. This means that the amount of tax you owe on dividends can vary. The greatest difference between eligible and non-qualifying dividends, to the extent that their effects occur at the time of taxation, is the rate at which these dividends are taxed. Non-eligible dividends are taxed at the normal personal income tax rate, as opposed to the prime rate for eligible dividends noted above. This means that people in a tax bracket see a difference in their tax rates depending on whether they have eligible or ordinary dividends. Quick Tip: A qualified foreign company must meet one of the following requirements, according to the IRS: (1) the corporation is incorporated in U.S. possession, (2) the company qualifies for the benefits of a comprehensive tax treaty with the U.S. Treasury, or (3) the company does not meet the first two definitions, but is “readily tradable” on a U.S.-based exchange. Eligible and unqualified (ordinary) dividends may have seemingly minor differences, but have a significant impact on total returns. Overall, most regular dividends paid by corporations in the U.S. can be considered eligible.

As the name suggests, common dividends – sometimes called unqualified dividends – are taxed at normal capital gains rates. The main difference between common dividends and eligible dividends is how they are taxed: regulated investment corporations (RICs) (mutual funds, exchange-traded funds, money market funds, etc.) and real estate investment trusts (REITs) can make capital gains distributions. Capital gains distributions are always reported as long-term capital gains. You must also report any undistributed capital gains that RICs or REITs have disclosed to you in a written notice. They report these undistributed capital gains to you on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains. For more information on reporting eligible dividends and capital gains distributions, see the instructions for Form 1040 (and Form 1040-SR). A foreign corporation is entitled to special tax treatment if it meets one of the following three conditions: The company is located in the United States. The company qualifies for the benefits of a comprehensive tax treaty with the United States, or the stock is readily tradable on an established U.S. securities market. A foreign corporation does not qualify if it is considered a passive foreign investment corporation. For most ordinary investors, the question of whether or not a dividend qualifies is usually not an issue.

The reason for this is that most regular dividends from U.S. companies are considered qualified. Nevertheless, especially for investors who focus on foreign companies, REITs, MLPs, and the other types of investment vehicles mentioned above, the difference between qualification and alternative can be significant when it comes to tax calculation. Most states tax dividends as normal income, so you pay the same rate for dividends as you do for the rest of your income. New Hampshire taxes all dividends at 5%, regardless of income level. But this tax will expire. It is to be completely repealed from 1 January 2027. Distributions that are considered a return of capital are not dividends.

A return on investment is a return on some or all of the investment in the company`s shares. A return on investment reduces the adjusted cost base of your inventory. For more information on the asset-based basis, see item 703. A distribution is generally considered a return of capital if the company making the distribution has no accumulated or current profits and profits. Once the adjusted cost base of your shares has been reduced to zero, any additional distributions other than dividends are taxable capital gains, which you report on Form 8949, Sale and Other Dispositions of Capital Assets, and Schedule D (Form 1040), Capital Gains and Losses. Eligible dividends were not part of the tax code until the 2003 law on reconciling tax breaks for jobs and growth. Previously, all dividends were taxed at the regular tax rate. The argument made by policymakers at the time was that lower rates for qualified dividends would encourage companies to reward long-term investors with higher dividend payments. If successful, this money would then circulate in the economy and generate growth.

To be taxed at the eligible dividend rate, the dividend must: You should receive a Form 1099-DIV from each payer, dividends and distributions for distributions of at least $10. If you are a partner in a partnership or beneficiary of an estate or trust, you may be required to report your share of all dividends the corporation has received, whether or not the dividend is paid to you. Your share of the corporation`s dividends is usually reported to you in a Schedule K-1. Eligible and common dividends are reported in separate fields on Internal Revenue Service Form 1099-DIV. The total number of ordinary dividends is shown in box 1a and the eligible dividends in box 1b. The two types of dividends are treated differently for tax purposes. If you receive substantial dividends, you may be subject to net capital gains tax (NIIT) and may have to pay estimated taxes to avoid a penalty. For more information, see topic 559, Net Capital Gains Tax, Estimated Taxes, or do I have to make estimated tax payments? If you receive more than $1,500 in taxable common dividends, you must report those dividends on Schedule B (Form 1040), Interest and Common Dividends. Eligible dividends were taxed at rates of 0%, 15% or 20% until fiscal 2017. The rate depended on the taxpayer`s usual tax bracket.

Then came the Tax Cuts and Jobs Act (TCJA) and changed things from January 2018. These following two tables show the tax rates for ordinary or unqualified dividends in 2020 and 2021, based on your taxable income and reporting status: A common exception is dividends paid on stocks held in a retirement account such as a Roth IRA, traditional IRA, or 401(k). These dividends are not taxed because any income or realized capital gains earned through these types of accounts are always tax-free. The difference can be significant. Depending on a few factors, many non-eligible dividends are taxed at your marginal tax rate, which can be as high as 37%. An eligible dividend is a dividend that meets a number of criteria that result in a lower long-term capital gains tax rate or no tax at all for some investors. For a dividend to be considered eligible, it must meet certain conditions. These include: But if you invest in a taxable account, the helmsman comes every year. So, focusing your dividend stock portfolio on stocks that pay a qualified dividend can make a big difference in the wealth you can build and hold before you`re ready to enjoy the fruits of your investment work.