What are Qualified Dividends and why are they important for your overall profit in long-term stock investing?
How can you invest to get lower taxes on dividends & How can you find the companies that meet the requirements?
What Are Qualified Dividends?
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 and therefore allows for a lower rate of taxation for longer-term investors by allowing for qualified dividends.
Go here for a detailed table on the tax savings of Qualified Dividends
How do Dividends Become Qualified
There are 2 elements to ensuring that you get a tax benefit using qualified Dividends.
1. The Right Companies on the Right Exchanges
To qualify for the maximum rate relief, all of the following requirements must be met.
The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.
(See Qualified foreign corporations, later.)
Some types of companies or not for profit organizations cannot have qualified dividends, see later section
2. Your Holding Period
The Internal Revenue Service Publication 17 – Tax Guide for Individuals says the following.
- You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
- The ex-dividend date is the first date following the declaration of a dividend on which
the buyer of a stock isn’t entitled to receive the next dividend payment. Instead, the seller will get the dividend.
- When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it.
So in short, you need to have held the stock for 2 months, in the 4 month period, 2 months before the Ex-Dividend Date. Publication 17 has some good examples of how this works.
Saving Tax Using Qualified Dividends
You can save a considerable amount of Tax on your Dividend Profits, which over a longer-term horizon could make up a significant portion of your investment profit with compounding, typically you would reduce your tax on dividends by at least 10%. See the possible tax benefits, see “Are Qualified Dividends Taxable”.
Qualified Dividends offer significant advantages vs Non Qualified Dividends
How Can I Find Which Companies Have Qualified Dividends
Essentially this is any company freely traded on the U.S. Stock Exchanges or the Exchanges in Countries that have a Tax Treaty with the U.S. See table below
See IRS Publication 17 for further information
Table 1. Countries with a Valid Tax Treaty Incorporating Qualified Dividends.
Companies registered in these countries will have dividends that can potentially be Qualified Dividends.
Which Dividends are not Qualified Dividends?
- Capital gain distributions from Real Estate Investment Trusts or Mutual Funds, this will be marked on your statement as “Capital Gains Dividends”
- Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations
- Dividends from a corporation that is a tax-exempt organization or farmer’s cooperative
- Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation
- Dividends on any share of stock to the extent you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
Qualified Dividends Summary
In short, if you are serious about investing for income through dividends then you will want to take advantage of the Qualified Dividends benefits of lower taxation through Capital Gains Tax and not be taxable through income tax.
Studies have shown over the long-term (e.g. 20 years) this will, if compounded, make a 20%+ improvement to your end investment return.