What is a 'Qualified Dividend'
Ordinary dividends that do not qualify for this tax preference are taxed at an individual's normal income tax rate. To qualify: 1. The dividend must have been paid by an American company or a qualifying foreign company. 2. The dividends are not listed with the IRS as those that do not qualify. 3. The required dividend holding period has been met.
BREAKING DOWN 'Qualified Dividend'
Regular dividends are classified as either qualified or unqualified. The category has tax implications that can impact an investor's return. Generally, most regular dividends are qualified.
The Holding Period
The Internal Revenue Service (IRS) requires investors to hold the stock for a minimum period of time to benefit from the lower tax rate. Common stock investors must hold the shares for more than 60 days during the 121-day period that starts 60 days before the ex-dividend date.
For preferred stock, the holding period is more than 90 days during a 181-day period that starts 90 days before the ex-dividend date.
According to the IRS's 2015 regulations, the tax rate on qualified dividends for those that have ordinary income taxed at 10% or 15% do not pay any tax on the dividends. Those that pay tax rates greater than 15% but less than 39.6% have a 15% rate on qualified dividends. The tax on qualified dividends is capped at 20%, which is for those individuals in the 39.6% tax bracket.
There are investments that do not qualify. This means investors will have to pay the higher tax rate, which is the one applied to ordinary income, to the dividend income. These include dividends paid by real estate investment trusts (REITs), master limited partnerships (MLPs), those on employee stock options, and those on tax-exempt companies. Those paid from money market accounts, such as deposits in savings banks, credit unions or other financial institutions, do not qualify and should be reported as interest income. Special one-time dividends are also unqualified.
A foreign corporation is a qualified foreign corporation if it meets one of the following three conditions: the company is incorporated in a U.S. possession, the corporation is eligible for the benefits of a comprehensive income tax treaty with the United States, or the stock is readily tradable on an established securities market in the United States. A foreign corporation is not qualified if it is considered a passive foreign investment company.