Qualified dividends and taxation can seem a little complex. We explain exactly how it works, as simply as possible.
Are Qualified Dividends Taxable?
In Short, Yes, Qualified Dividends are Taxable. All dividends are taxable, just like all income is taxable. But in most circumstances, you can lower your tax rate or even have your dividends be subject to a tax rate of 0%. In all instances, you must declare your dividends on your Tax Return to establish your effective tax rate.
What is a Qualified Dividend?
Qualified Dividends are typically either Regular Cash Dividends or Extra Dividends that “Qualify” for different Tax Treatment in the U.S.A. As an investor, you are subject to taxation on your profits by either Income Tax or the lower Long-Term Capital Gains Tax.
As an employee, you are taxed on your Income e.g., Income Tax.
But the government wants to encourage Long-term investing in U.S. companies, not short-term speculation. It, therefore, allows for a lower rate of taxation for longer-term investors by allowing for qualified dividends.
Qualified & Ordinary Dividend Tax Rates
The table below highlights the difference between the Income Tax on Ordinary Dividend Payments and the Long-Term Capital Gains Tax on Qualified Dividends.
|Ordinary vs. Qualified Dividend||Ordinary Dividend||Qualified Dividend|
|Tax Applied||Income Tax||Long-Term Capital Gains Tax|
|Holding Requirements||Must hold stock two days before the ex-dividend date||Must hold stock 60 days before the ex-dividend date (for Common Stock) or 90 Days before the ex-dividend date (for preferred stock)|
Company Incorporated in the U.S. or a U.S. Territory
Company Stock Traded on a U.S Stock Exchange
Foreign Corporations in a Country eligible under a specific tax treaty.
|10% Ordinary Income Tax Rate||10%||0%|
|15% Ordinary Income Tax Rate||15%||0%|
|25-35% Ordinary Income Tax Rate||25% – 30%||15 – 18.8%|
|39.6% Ordinary Income Tax Rate||39.6%||20 – 23.8%|
Table 1: Stock Dividend Tax Rate.
How Can I Lower My Tax Rate or Pay 0% Tax on Dividends?
As you can see, the regulations can make a significant difference to your income. If you hold the stock for more extended periods and are in the 10% to 15% income tax bracket, your income from dividends will be effectively tax-free at 0%.
This is as long as your dividend award does not take you into the 25% or above tax bracket, in this case, you would be charged for any dividend in that bracket at the appropriate rate.
And for the other tax brackets, there is a reduction in taxation by 40 to 50%, e.g., from 25% to 15%.
Here the details are essential; this means you need to get the holding period right. For further information, see What is a Qualified Dividend?
Positive Impact for the Long-Term Investor
If you are investing over 20 years and compounding your gains over this timeframe, the lower rate of tax on your dividends could amount to a 20 – 30% increase in your overall investment.
To qualify for the Long-Term Capital Gains Tax Rate, the company you invest in would need to be a U.S. Registered Company (or registered in any other U.S. Domain) with shares freely exchanges on a U.S. Stock Exchange. Alternatively, a foreign company with the correct level of Tax Treaty enabling Qualified Dividends.
As you can imagine it is essential to understand the difference between ordinary and qualified dividends