Qualified dividends, as defined by the United States Internal Revenue Code, are ordinary dividends that meet specific criteria to be taxed at the lower long-term capital gains tax rate rather than at higher tax rate for an individual’s ordinary income. The rates on qualified dividends range from 0 to 23.8%.
What is a ‘Qualified Dividend’
A qualified dividend is a type of dividend to which capital gains tax rates are applied. These tax rates are usually lower than regular income tax rates.
Explaining ‘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.
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.
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