Qualified dividends give you a passive income advantage over your ordinary working earned income. By investing money into companies that pay qualified dividends, you can get a passive income stream that has a major tax advantage. If you are in the 10-12% regular income tax bracket, you pay a 0% qualified dividend tax rate. If you are in the 22%-32% regular income tax bracket, you pay a 15% qualified dividend tax rate. If you are in the 35-37% (highest) tax brackets, you only pay a 20% qualified dividend tax rate. As you can see, the more qualified dividend income you have, the more tax savings you have over ordinary income.
Ordinary Dividends
Ordinary dividends are paid out of the earnings and profits of a corporation and are paid to you on stock or holdings you have with the paying company. These dividends are generally ordinary income, not capital gain income. You can assume that dividends you receive on common stock and preferred stock are ordinary dividends unless the corporation tells you otherwise.
Qualified Dividends
Qualified dividends are ordinary dividends meeting special requirements to qualify for the 0%, 15% or 20% tax rate. All the following must be true:
- Dividends must have been paid by a U.S. corporation or qualifying foreign corporation.
- Holding period requirements were met:
- You must have held the stock for 60 days during the 121-day period that begins 60 days before the ex-dividend date. This mandatory holding period prevents traders from earning tax-advantaged income on stocks that they hold for only a few days.
- The dividends are not:
- Capital gain distributions
- From a tax-exempt corporation (example REIT)
- From an employee stock ownership plan maintained by the paying corporation
- Payments that are in lieu of dividends
- Actually treated as interest income
To have a clear understanding of qualified and unqualified dividends and how it will affect overall returns, you should stay in communication with your tax accountant or broker.
