Dividend income is taxable but it is taxed in different ways depending on whether the dividends are qualified or nonqualified. Investors typically find dividend-paying stocks or mutual funds appealing because the return on investment (ROI) includes the dividend plus any market price appreciation.
- The tax rate for dividends depends on whether they are qualified or nonqualified.
- Qualified dividends, which include those paid by U.S. companies, are taxed the long-term capital gains rate.
- Nonqualified, or ordinary, dividends, such as those paid by real estate investment trusts (REITs), are taxed at the regular income rate.
A qualified dividend is taxed at the lower long-term capital gains tax rate instead of at the higher tax rate used on an individual’s regular income. To be eligible for this special tax rate, a dividend must be paid by one of the following:
- A U.S. company
- A company in U.S. possession
- A foreign company residing in a country that is eligible for benefits under a U.S. tax treaty
- A foreign company’s stock that can be easily traded on a major U.S. stock market
These dividends must also meet holding period requirements. The stock must have been held in excess of 60 days during the 121-day period beginning 60 days before the ex-dividend date. In the case of preferred stock, the stock must have been held in excess of 90 days during the 181-day period beginning 90 days before the ex-dividend date if the dividends are due in a period of time longer than 366 days.
Qualified Dividend Taxes
Qualified dividends are tax-free for individuals in the 10%, 12%, and 22% tax brackets (or those earning less than $80,000 per year). For individuals in the 22%, 24%, 32%, and 35% tax brackets, dividends receive a 15% tax rate. Dividends are taxed at a 20% rate for individuals whose income exceeds $209,425 (those who fall in either the 35% or 37% tax bracket). The breakdown of taxes on qualified dividends is as follows:
|Dividend Tax Rate|
|Tax Bracket||Tax Rate on Regular Income||Tax Rate for Qualified Dividends / Capital Gains|
|$9,951 to $40,525||12%||0%|
|$40,526 to $79,999||22%||0%|
|$80,000 to $86,375||22%||15%|
|$86,376 to $164,925||24%||15%|
|$164,926 to $209,425||32%||15%|
|$209,426 to $441,449||35%||15%|
|$441,450 to $523,600||35%||20%|
Meanwhile, there are nonqualified, or ordinary, dividends. These dividends do not meet the qualified dividend requirements and are treated as short-term capital gains. These nonqualified dividends are taxed at the same rates as an individual's regular income. Thus, in the chart above, nonqualified dividends are taxed at the "Tax Rate on Regular Income."
Gregory Hart, CFP
Haddon Wealth Management, LLC, Haddonfield, N.J.
Generally speaking, dividend income is taxable. This is assuming that it is not distributed in a retirement account, such as an IRA, 401(k) plan, etc., in which case it would not be taxable. Here are two common examples of dividend income subject to taxes:
If you own a stock, such as ExxonMobil for example, and receive a quarterly dividend (in cash or even if it is reinvested), it would be taxable dividend income.
Or, for example, let’s say that you own shares in a mutual fund and it distributes dividend income every month. These dividends would also be considered taxable dividend income.
Again, both of these examples apply to dividends received in non-retirement accounts.