What is a Qualified Dividend
To qualify for the maximum tax rates of 0%, 15% or 20% that apply to long-term capital gains, qualified dividends must meet the following requirements, as outlined by the Internal Revenue Service (IRS):
- The dividend must have been paid by a U.S. company or a qualifying foreign company.
- The dividends are not listed with the IRS as those that do not qualify.
- The required dividend holding period has been met.
BREAKING DOWN Qualified Dividend
Regular dividends are classified as either qualified or ordinary, each with different tax implications that impact an investor's net return. The tax rate on qualified dividends for investors that have ordinary income taxed at 10% or 15% is 0%. Those that pay income tax rates greater than 15% but less than 39.6% have a 15% tax rate on qualified dividends. The tax rate on qualified dividends is capped at 20%, which is for individuals in the 39.6% tax bracket. These tax rates on long-term capital gains are current through the 2018 calendar year.
Qualified dividends are listed in box 1b on IRS Form 1099-DIV, a tax form sent to investors who receive distributions during the calendar year from any type of investment. Box 1a on the form is reserved for ordinary dividends, which according to the IRS, are the most common type of dividend paid to investors from a corporation or mutual fund.
More on Qualified Dividend Requirements
Qualifying foreign companies
A foreign corporation qualifies for the special tax treatment 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.
Dividends that do not qualify
Some dividends are automatically exempt from consideration as a qualified dividend. 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. Dividends 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. Lastly, qualified dividends must come from shares that are not associated with hedging, such as those used for short sales, puts and call options. The aforementioned investments and distributions are subject to the ordinary income tax rate.
The Holding Period
The IRS requires investors to hold shares for a minimum period of time to benefit from the lower tax rate on qualified dividends. 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.