Not all stocks pay dividends. However, If you own stock that pays dividends your dividend income will be classified as either “Qualified” or “Ordinary”. The fund that pays the dividends will send you a Form 1099-DIV that will tell you type of dividend. On Form 1099-DIV Qualified dividends are listed in box 1b and Ordinary dividends are listed in box 1a. Ordinary dividends are taxed at your usual income tax rate. Qualified dividends are taxed at the long-term capital gains tax rate, which is significantly lower. The table below compares the tax rate you will pay for Ordinary dividends vs Qualified dividends.
“Ordinary” Income/Dividend Tax Rate “Qualified” Dividend Tax Rate
1) 10% or 15% 0%
2) 25% or 28% or 33% or 35% 15%
3) 39.6% 20%
Historically, the tax rate on your qualified dividend income was directly linked to (but usually less than) your income tax rate. However, the 2017 Tax Cuts and Jobs Act (TCJA) created designated income brackets for the three qualified dividends tax rates (0%, 15%, and 20%). These brackets are independent of ordinary income tax brackets and will be adjusted for inflation annually. Therefore, the tax rate on your qualified dividends could change even if your income tax rate does not, or vice versa.
For a dividend to be “Qualified” it must meet the following two main criteria:
1) You must meet the holding period requirements. The shares must have been owned by you for more than 60 days of the “holding period” — which is defined as the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the date the stock trades without the dividend priced in. In other words, the ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment.
2) Must be issued by a U.S. corporation, or by a foreign corporation that readily trades on a major U.S. exchange, or by a corporation incorporated in a U.S. possession or a foreign corporation located in a country that is eligible for benefits under a U.S. tax treaty.