If you own corporate stocks or invest in mutual funds, you may receive periodic dividend payments during the year. The companies and financial institutions that pay these dividends will report their annual payments to you on a 1099-DIV form, which also tells you the amounts that are qualified dividends. Since the tax you will owe on each type of dividend can be significantly different, it’s important to understand the difference between the payments reported as ordinary dividends and those that are qualified dividends.
Ordinary dividends are the payments you receive from the earnings and profits of a corporation or mutual fund in which you invest. For example, if you own shares of Disney stock and the corporation’s board of directors decides to issue dividend payments to shareholders because of a profitable year; the payments are treated as ordinary dividends.
However, it’s important to distinguish an ordinary dividend payment from other types of distributions. As a general rule, a distribution that isn’t paid from earnings and profits, such as a return of your initial investment in the stock, isn’t subject to the ordinary dividend tax rules.
Qualified Ordinary Dividends
The most important thing to remember about qualified dividends is that they are a category of ordinary dividends that are subject to special tax rules that can save you money on your tax return. In other words, all qualified dividends are ordinary, but not all ordinary dividends are qualified.
To be a qualified dividend, the payment must be made by a U.S. corporation or by a company that’s incorporated in a U.S. possession, in a foreign country that has a tax treaty with the U.S. that includes an exchange of information program or if the stock trades on a U.S. stock exchange.
In addition, you must own the stock for at least 61 days during the 121-day period that starts 60 days prior to the ex-dividend date. The ex-dividend date is the first day that new shareholders will not be eligible to receive the previously declared dividend payment – meaning you must own the stock before the ex-dividend date to get the dividend. Moreover, qualified dividend treatment never applies to certain types of payments, such as those that resemble interest more than a dividend.
Taxing Qualified Dividends
Dividend payments are generally taxed at the same ordinary tax rates that your other income is subject to, such as your salary from work and the interest you earn from a bank account. Because the ordinary personal income tax rates are progressive in nature, the taxes you will pay on dividends can be as high as 37 percent – but this always depends on the amount of other income you report.
For those payments you receive that are qualified dividends, the maximum rate of tax you will pay is 20 percent, while many taxpayers may even qualify to receive the dividends tax free. This is because the law taxes qualified dividends using the same rates that apply to net capital gains. As a result, you’ll pay a 20-percent tax on qualified dividends only if your income is over $425,800 for a single taxpayer, or $479,000 for a joint filer, as of tax year 2018. If your tax bracket is $38,600 or lower for singles, or $77,200 or lower for joint filers, you receive the qualified dividends tax-free.
Every company or financial institution that makes annual dividend payments totaling $10 or more must report those payments on a 1099-DIV and send a copy to you and the IRS. When you receive the form you want to focus on boxes 1a and 1b. Box 1a reports the total ordinary dividend payments and box 1b reports the amount reported in box 1a that represents qualified dividends. When you prepare your tax return, you will report these two amounts on separate lines.