How are Qualified and Ordinary Dividends Taxed?

Rate this post
How are Qualified and Ordinary Dividends Taxed?

Dividends are taxed differently in the United States depending on whether they are classified as “qualified dividends” or “ordinary dividends” under the Internal Revenue Code. (Officially, ordinary dividends are also known as nonqualified dividends.) Qualified dividends are taxed at the same rates as capital gains, which are lower than regular income tax rates.

Ordinary dividends (usually those paid out from most common or preferred stocks) are taxed at the same rates as conventional federal income taxes, ranging from 10% to 37% for tax years 2021 and 2022. Ordinary dividends are taxed at the same rates as normal income, such as salary or wages, by investors. Income and capital gains tax rates fluctuate over time, although in recent years, the latter has been much lower than the former.

Key Takeaways

  • Dividends are taxed differently in the United States depending on whether they are classified as “qualified dividends” or “ordinary dividends” under the Internal Revenue Code.
  • Qualified dividends are taxed at the same rates as capital gains, which are lower than regular income tax rates.
  • Ordinary dividends are taxed at the same rates as conventional federal income taxes, ranging from 10% to 37%.

Qualified Dividends vs. Ordinary Dividends

A dividend is a percentage of a company’s profits that is given to shareholders directly. Companies that pay dividends pay a predetermined amount per share that may be adjusted up or down with each earnings period (typically a calendar quarter) depending on the company’s performance. The investor is required to pay taxes on their dividends, but the amount depends on whether the dividends are qualified or ordinary.

  Long-Term vs. Short-Term Capital Gains: What’s the Difference?

Qualified dividends, which get preferential tax treatment, must fulfill a few requirements. They must be issued by US companies that are publicly traded on major exchanges such as the Dow Jones or the NASDAQ. Out of a 121-day holding period, the investor must possess them for at least 60 days. Certain dividends, such as those through an employee stock ownership plan or issued by a tax-exempt organization, are not qualified.

Apart from the tax status, there is no discernible difference between qualified and ordinary dividends.

Qualified-Dividend Tax Treatment

Qualified dividends are preferred by investors because they are subject to lower tax rates, notably those assessed on long-term capital gains rather than those applied on ordinary income. That holds true regardless of the investor’s tax band, however the largest savings go to those in the top two brackets, where the tax rate differential between the two kinds of dividends may be as high as 20%.

Currently, qualifying dividends are taxed at three different rates: 0%, 15%, and 20%.

The tax brackets are as follows:

Dividend Tax Rates for Tax Year 2021
Tax RateSingleMarried, Filing JointlyMarried, Filing SeparatelyHead of Household
0%$0 – $40,400$0 to $80,800$0 to $40,400$0 to $54,100
15%$40,401 – $445,850$80,801 to $501,600$40,401 to $250,800$54,101 to $473,750
20%$445,851 or more$501,601 or more$250,801 or more$473,751 or more

Dividend Tax Rates for Tax Year 2022
Tax RateSingleMarried, Filing JointlyMarried, Filing SeparatelyHead of Household
0%$0 to $41,675$0 to $83,350$0 to $41,675$0 to $55,800
15%$41,676 to $459,750$83,351 to $517,200$41,676 to $258,600$55,801 to $488,500
20%$459,751 or more$517,201 or more$258,601 or more$488,501 or more

Individuals with incomes of $200,000 or more, and married couples with incomes of $250,000 or more, pay an extra 3.8% on investment income, including qualifying dividends.

  Taxable Income: What It Is, What Counts, and How To Calculate

Example of How Dividends Are Taxed

Consider an investor who owns 5,000 shares of Company X and receives $2 in regular dividends each year, for a total of $10,000 per year. Assume he is unmarried and earns a taxable income of $50,000 per year, putting him in the 22% marginal tax bracket for ordinary income.

Because ordinary dividends are not taxed differently, he pays 22%, or $2,200, in taxes on them. If his dividend is eligible, he pays a 15% rate on his earnings, or $1,500.

Assume the same investor, who is still single, gets $1 million in taxable income each year, excluding dividends on 50,000 shares of Company X stock. His annual dividend is $100,000 at $2 per share. He would owe $37,000 in federal taxes on the profits if they were ordinary, but just $20,000 if they were qualified, a $17,000 reduction.

What Rates Are Dividends Taxed At?

If your dividends are eligible, they will be taxed at the capital gains tax rate of 0%, 15%, or 20%, depending on your tax status. Ordinary dividends (nonqualified dividends) are taxed at your standard marginal income tax rate.

Are Dividends Taxed Twice?

Dividends are taxed twice, which is known as double taxation. The first wave of taxes is levied on a company’s profits. Dividends are paid out of a company’s profits and given to shareholders. Shareholders must then pay tax on the dividends they receive.

How Do I Minimize the Taxes I Pay on Dividends?

One strategy to reduce dividend taxes is to strive to have qualified dividends, which have a lower tax rate than nonqualified payouts. Another option is to create a tax-advantaged brokerage account, such as an IRA, where you may delay paying taxes until you reach a reduced tax rate when you remove from the account.

  Induced Taxes Definition

The Bottom Line

Dividends may be a terrific method to generate income from your assets, but they are taxed as well. Depending on whether the dividend is qualified or nonqualified, you will be taxed at either your regular income tax bracket or the capital gains tax bracket, with the latter normally having a lower tax rate.

You are looking for information, articles, knowledge about the topic How are Qualified and Ordinary Dividends Taxed? on internet, you do not find the information you need! Here are the best content compiled and compiled by the achindutemple.org team, along with other related topics such as: Tax.

Similar Posts