Attention investors…do you have a firm understanding of the different types of dividends and the tax implications of each? The way that dividends are treated for tax purposes plays a central role in an investor’s return on investment (ROI). Here’s a breakdown of qualified vs. ordinary dividends.

What are qualified dividends?

Dividends are considered “qualified” if they meet the following requirements:

• The dividends must have been paid by a U.S. corporation or a qualified foreign corporation
• Investors must adhere to a minimum holding period
• Shares must be “unhedged”- i.e. during the holding period, the shares were not protected against loss by balancing or compensating contracts/transactions

What are ordinary dividends?

Sometimes referred to as “nonqualified dividends,” these are the most common distribution from a corporation or mutual fund. Ordinary dividends are paid out of earnings and profits and are treated as ordinary income. Ordinary income is most earnings other than long term capital gains.

Ordinary dividends include:

• One-time dividends
• Dividends from passive foreign investment companies
• Employee stock option payments
• Dividends paid by select foreign entities
• Dividends paid out by tax exempt companies
• Dividends paid in the money market or savings accounts
• Dividends held in an individual retirement account (IRA)

What is the difference in taxation?

The most significant difference between the two is that ordinary dividends are taxed at ordinary income rates, while qualified dividends receive more favorable tax treatment by being taxed at lower capital gains rates.

If your ordinary income is taxed at 10-12%, the tax rate is 0% on qualified dividends. Conversely, if your taxable income is taxed at 22-35% (for married filing jointly with taxable incomes between $89,251 to $553,850 and $44,626 to $492,300 for single filers), you will be assessed a 15% tax rate on qualified dividends. Taxable income exceeding $553,850 for married filing jointly or $492,300 for single filers will result in the qualified dividends being taxed at a 20% capital gains tax.

Additionally, if your modified adjusted gross income exceeds $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately, there is a 3.8% Net Investment Income Tax (NIIT).

Special holding rule requirements apply in order for a dividend to receive favorable tax treatment. For common stock, a share must be held more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. Under IRS guidelines, the ex-dividend date is the date after the dividend has been paid and processed and any new buyers would be eligible for future dividends. For preferred stock, the holding period is more than 90 days during the 181-day period beginning 90 days before the stock’s ex-dividend date.

For more information on how your dividends should treated for tax purposes please contact any member of our Private Client Services Group.