Dividends can be a valuable source of investment income, but the tax rules aren’t always straightforward. Some dividends are taxed at ordinary income rates, while others may qualify for lower tax rates. Understanding how dividends are taxed, when those lower rates apply, and how dividend income is reported can help you feel more prepared at filing time.
How are dividends taxed?
Dividends are taxable, but the tax treatment depends on the kind of dividend you receive. Most dividend income falls into one of two tax classifications: ordinary or qualified. According to the Internal Revenue Service (IRS), you can find both on Form 1099-DIV, with total ordinary dividends in box 1a and the portion that may qualify for lower rates in box 1b.
Ordinary dividends versus qualified dividends
The main difference between ordinary and qualified dividends is the tax rate. While ordinary dividends are taxed at a normal marginal tax rate, qualified dividends are taxed at a lower rate. We’ll explore the differences among the tax implications below.
What is an ordinary dividend?
Ordinary dividends, otherwise known as nonqualified dividends, are taxed as ordinary income, meaning a regular income tax rate. This type of dividend is the most common and often regarded as the default. You may receive these kinds of dividends as distributions from corporations or mutual funds.
Ordinary dividends are found in box 1a of Form 1099-DIV and generally go on line 3b of Form 1040 or 1040-SR.
What is a qualified dividend?
Unlike ordinary dividends, qualified dividends are subject to lower tax rates. The qualified dividend tax rate mirrors long-term capital gains tax rates: 0%, 15%, or 20%. How much you’re taxed will depend on your filing status and taxable income.
Qualified Dividend Requirements
There are a couple of requirements to qualify:
Paid by a corporation
The dividend generally must be paid by a U.S. corporation or a qualified foreign corporation. A qualified foreign corporation must be incorporated in a U.S. territory, eligible for benefits of a comprehensive income tax treaty with the U.S., or have stock that’s tradable on an established securities market in the U.S.
Holding period requirement
For most common stock, you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The holding period doesn’t have to fall within a single tax year for the dividend to qualify for lower tax rates.
For certain preferred stock, if the dividends cover periods totaling more than 366 days, you must hold the stock for more than 90 days during the 181-day period that begins 90 days before the ex-dividend date.
Note: Keep in mind that though a qualified dividend is taxed at the same rate as long-term capital gains, it isn’t a long-term capital gain itself.
Are stock dividends taxed?
What is the 45-day rule for dividends?
The IRS 45-day rule applies to short sales. If you or your brokerage borrows stock for a short sale, you may have to pay the lender an amount equal to any dividends paid while your short sale is open.
You can usually deduct those payments only if you keep the short sale open for at least 46 days and you itemize deductions. If deductible, you can report them as investment interest on Schedule A.
However, if you close the short sale by the 45th day, you typically can’t deduct the payment. Instead, you add that amount to the cost basis of the stock used to close the short sale.
Will dividends increase my taxes?
Yes, dividends increase your taxable income, and therefore, your tax liability. What changes is the amount you’re taxed, which depends on the tax treatment of the dividends.
If the dividends are qualified, they’ll be taxed at a lower rate, whereas if they’re ordinary, they’ll be taxed at a normal rate. Your overall taxable income will also play a role in how much you’re taxed.
For example, if you’re a single filer and have $50,000 of taxable income and receive $1,000 in dividends, your taxable income becomes $51,000. If those dividends are qualified, they’d generally be taxed at 15%. If they’re ordinary dividends, they’d generally be taxed at 22%.
Net Investment Income Tax (NIIT)
Another factor that can increase your taxes when considering dividends is whether you’re subject to the Net Investment Income Tax (NIIT). The NIIT is an additional 3.8% tax that may apply if your income exceeds a certain limit. Dividends usually count toward that tax.
FAQs
The bottom line
Dividends can be a useful source of investment income for taxpayers, but they aren’t all taxed the same way. Ordinary dividends are generally taxed at ordinary income rates, while qualified dividends may be taxed at lower long-term capital gains rates. Carefully reading your Form 1099-DIV is the starting point for figuring out how your dividends affect your return.
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