Guide to Qualified Dividends and Ordinary Dividends: How they are taxed
Understanding the distinction between qualified dividends and ordinary dividends is essential for effective tax planning.
Ordinary Dividends
Definition: Payments made by corporations to shareholders from their earnings.
Taxation: Taxed as ordinary income, with rates ranging from 0% to 37%, depending on your tax bracket.
Criteria for Ordinary Dividends
It’s pretty simple… All Dividends that do not meet the criteria to be qualified.
Qualified Dividends
The Basics
Definition: A subset of ordinary dividends that meet specific IRS criteria, allowing them to be taxed at the lower capital gains tax rates.
Taxation: Subject to capital gains tax rates of 0%, 15%, or 20%, based on taxable income.
Criteria for Qualified Dividends
For a dividend to be classified as qualified:
Payer Requirements:
Issued by a U.S. corporation or a qualified foreign corporation.
Holding Period:
You must hold the stock for more than 60 days during the 121-day period that starts 60 days before the ex-dividend date.
Example: Qualified Dividend Timeline
Stock Purchase and Ex-Dividend Date
You buy 100 shares of XYZ Corp. on April 1, 2024.
The ex-dividend date is April 15, 2024.
XYZ Corp. pays a dividend of $1 per share on May 1, 2024.
Holding Period Requirement
The IRS requires you to hold the stock for more than 60 days within a 121-day period starting 60 days before the ex-dividend date.
The 121-day period runs from February 15, 2024 (60 days before April 15) to June 15, 2024.
To meet the holding requirement, you must hold the stock for at least 61 days within this window.
Qualifying the Dividend
If you hold the stock from April 1 to June 15 (76 days), the dividend is qualified and taxed at capital gains rates.
If you sell the stock on May 10, 2024, you only held it for 40 days, so the dividend is ordinary and taxed at higher ordinary income rates.
Summary
Held for 61+ days in the required window → Qualified Dividend
Held for less than 61 days → Ordinary Dividend
More here: IRS Website TC404
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About the author: Finn Price, CPFA, CEPA, is a business owner and wealth manager at Railroad Investment Group. He helps successful entrepreneurs & individuals with concentrated stock positions in their 30s, 40s and 50s build, organize, protect and transfer their wealth.
Note: this article is general guidance and education, not advice. Consult your money person or your attorney for financial, tax, and legal advice specific to your situation.
Securities and advisory services offered through LPL Financial, a registered investment Advisor, Member FINRA/SIPC.
