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.

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 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 or 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 dividends are tax-free for individuals in the 10% and 12% tax brackets (or those earning less than $39,375 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 $434,500 (those who fall in either the 35% or 37% tax bracket). Nonqualified dividends, or dividends that do not meet these requirements, are treated as short-term capital gains and taxed at the same rates as an individual's regular income.

The Advisor Insight

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.

Gregory Hart
Haddon Wealth Management, LLC
Haddonfield, NJ