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What Is the Difference Between Qualified & Non Qualified Dividends?

What Is the Difference Between Qualified & Non Qualified Dividends?

Every business is out to make returns on investment, including stocks portfolio. But these dividends from stock are not equal, resulting in different treatment when it comes to taxation. 

Uncle Sam has two dividend taxes: qualified and nonqualified dividends. The gap between the two is that the former has more tax advantage since it uses a capital gains rate while the latter is taxed at ordinary income rates. The amount that Uncle Sam will take as tax from your dividends affects the ROI, so it is important to understand the tax laws concerning different dividends. 

What Is Dividend Income? 

Dividend income is defined as part of a company's profit paid to a stockholder as income regularly. However, not all companies pay dividends, but it is a scale-through formula for declining stocks. Stocks with slow growth usually amass significant dividend yield and are considered value stocks. Value investing is the number one strategy many stock investors use in a recessed or bear market. Both terms are taxable by law but understanding them will enlighten the difference.   

Qualified Dividends

The IRS uses capital gain tax rates to collect their share from qualified dividends, placing it on a lower tax rate than non qualified or ordinary dividends. In addition, low-income taxpayers may not pay taxes to the federal government on their qualified dividends. Taxpayers pay a capital gains tax rate of 20%, 15%, or 0% on their qualified dividends based on their earnings. Qualified dividends often have more tax advantages than ordinary dividends. However, there are some hurdles to cross:

  • The dividends must come from a US company or a qualified international company.

  • Suppose you buy your stock before the closing date and keep it for at least 61 days before initiating the next dividend; then, it is considered a qualified dividend.

  • The stock must last for the holding period. To consider mutual funds and common stock as capital gains, it must stay 60 days and 90 days for preferred stock. However, failure to reach the holding period will disqualify the stock. 

  • Those dividends not included in the IRS list do not qualify.

  • Capital gain distributions of earnings from tax-exempt organizations are not considered dividends.

Qualified Dividend Example

Qualified dividends are a way to increase your income but must be treated separately from ordinary income. A single filer can get a 0% tax rate with a taxable income of $41,675 or less. Married on a joint tax status can withhold $83,350. So, if a couple earns $75,000 taxable income annually, the IRS marginal tax rate is 12% for amounts between $20,551 and $83,550. In essence, a person with $2000 will pay nothing in tax.

Ordinary (Nonqualified) Dividends

Ordinary or nonqualified dividends are corporate-owned and do not cross the line of qualified dividends. The IRS uses the individual marginal income tax rate to cut their portion. The marginal tax rate affects every dollar earned as income by the investor. However, an investor can get a range of tax-advantaged accounts like IRA (traditional Individual Retirement Accounts) to save money. 

Furthermore, the IRS informs every taxpayer that ordinary dividends include the amount paid on common or preferred stock unless the insurer or an adviser tells you differently. Here are businesses whose stocks are considered ordinary dividends instead of qualified dividends.

  • Banks and thrifts that pay on deposits

  • Foreign corporations

  • Money market funds

  • Real Estate Investment Trusts (REIT) 

  • Master Limited Partnerships (MLP) 

  • Limited Liability Partnerships (LLP) 

  • Employee Stock Ownership Plans

Ordinary Dividend Example

An individual that earns $41,775 as taxable income annually and a bonus of $500 quarterly or $2,000 could give 10% of the first $10,275 ($1,027.50) to the IRS. Furthermore, any amount above $10,275 ($3,780) will be taxed 12%.

Keep in mind that all incomes have different tax rates ranging from 10% to 37% tax bracket. Dividend income works on the same tax rule.



Tiffany Gaskin
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