The tax treatment of dividends in the U. S. depends on whether they are categorized as qualified dividends or ordinary dividends—also known as nonqualified dividends—under the Internal Revenue Code (IRC). The capital gains tax rate and the qualified dividend tax rates are the same. These rates are lower than ordinary income tax rates.
The tax rates for ordinary dividends, which are normally paid out from the majority of common or preferred stocks, are the same as standard federal income tax rates, or 2010% to 237 percent for the 202023 and 202024 tax years. Ordinary dividends are taxed by investors at the same rates as their regular income, such as salaries or wages. While capital gains and income tax rates fluctuate over time, the latter has been significantly lower than the former in recent years.
As an investor, understanding the different types of dividends and their tax implications is crucial for maximizing your return on investment. This guide delves into the concept of ordinary dividends, explaining their definition, taxation, and key characteristics.
What are Ordinary Dividends?
Ordinary dividends, also known as non-qualified dividends, are the most common type of distribution from corporations or mutual funds. They are paid out of the company’s earnings and profits and are treated as ordinary income for tax purposes This means they are taxed at the same rate as your other taxable income, such as wages or salaries.
Key Characteristics of Ordinary Dividends:
- Taxed as ordinary income: Ordinary dividends are taxed at your marginal tax rate, which can range from 10% to 37% depending on your income level.
- No special holding period requirement: Unlike qualified dividends, ordinary dividends do not have a minimum holding period requirement. You can receive the dividend even if you have held the stock for a short period.
- Examples of ordinary dividends:
- One-time dividends
- Dividends from passive foreign investment companies
- Employee stock option payments
- Dividends paid by select foreign entities
- Dividends paid out by tax-exempt companies
- Dividends paid in money market or savings accounts
- Dividends held in an individual retirement account (IRA)
Taxation of Ordinary Dividends:
The tax rate for ordinary dividends depends on your taxable income. Here’s a breakdown:
- Taxable income up to $41,775 (single filers) or $83,550 (married filing jointly): 10% tax rate
- Taxable income between $41,775 and $89,075 (single filers) or $83,550 and $178,150 (married filing jointly): 12% tax rate
- Taxable income between $89,075 and $170,050 (single filers) or $178,150 and $340,100 (married filing jointly): 22% tax rate
- Taxable income between $170,050 and $215,950 (single filers) or $340,100 and $431,900 (married filing jointly): 24% tax rate
- Taxable income between $215,950 and $539,900 (single filers) or $431,900 and $647,850 (married filing jointly): 32% tax rate
- Taxable income exceeding $539,900 (single filers) or $647,850 (married filing jointly): 37% tax rate
Additional Considerations for Ordinary Dividends:
- Net Investment Income Tax (NIIT): If your modified adjusted gross income exceeds $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately, you may be subject to a 3.8% NIIT on ordinary dividends.
- State and local taxes: Some states and localities may also impose taxes on ordinary dividends.
Understanding ordinary dividends and their tax implications is essential for making informed investment decisions. By considering the tax rates and other factors discussed in this guide, you can optimize your investment strategy and maximize your after-tax returns. Remember to consult with a tax professional for personalized advice on your specific situation.
Additional Resources:
- IRS Topic No. 404, Dividends: https://www.irs.gov/taxtopics/tc404
- Kahn, Litwin, Renza & Co., LLP: https://kahnlitwin.com/blogs/tax-blog/how-do-i-know-if-my-dividends-are-qualified-or-ordinary
Keywords: ordinary dividends, non-qualified dividends, taxation, tax rates, investment, income, IRS, NIIT, state and local taxes
Example of How Dividends Are Taxed
To visualize the distinction between these two tax treatments, consider an investor who owns 5,000 shares of Company X and receives $2 in annual ordinary dividends, or $10,000 total. Let us assume that they are a single couple with taxable income of $50,000 per year, placing them in the 20%222%%20marginal income rate bracket for ordinary income.
Ordinary dividends are not subject to special tax treatment; therefore, the amount of taxes paid on them is 2.22%, or $2,200. Nonetheless, if their dividend qualifies, they pay a 2015 rate that is determined by their income, or $1,500.
Assume the same investor, who is still unmarried, has $1 million in taxable income annually (not including dividends from 50,000 shares of Company X stock). At $2 per share, their yearly dividend is $100,000. Taxed at the highest marginal rate of 33.7 percent, they owe $37,000 in federal taxes on dividends if they are ordinary, but only $20,000 if they meet certain qualifications, amounting to a $17,000 savings.
Qualified Dividends vs. Ordinary Dividends
A dividend is a sum of money given to shareholders directly from a company’s profits. Businesses that pay dividends set a fixed amount per share, which they can change based on the company’s performance at each earnings period (usually a calendar quarter). Dividends are subject to taxation by the investor; the amount of tax due depends on whether the dividends are qualified or ordinary.
Dividends that qualify for preferential tax treatment must fulfill certain requirements. They must be issued by U. S. companies that are openly traded on significant markets, like the Nasdaq or Dow Jones These must be owned by the investor for a minimum of 60 days during the 121-day holding period. Certain dividends aren’t qualified for qualified status, like those from employee stock ownership plans or those from tax-exempt organizations.
Apart from their tax treatment, qualified and ordinary dividends are not significantly different from one another.
Dividends, Ordinary and Qualified
FAQ
What is difference between ordinary and qualified dividends?
What is ordinary dividend in accounting?
What is the difference between ordinary and special dividends?
Who pays ordinary dividends?
What is the difference between ordinary dividends and qualified dividends?
The main differences between ordinary dividends and qualified dividends are the rates at which the gains are taxed. Through the years, these tax rates have changed through several acts of Congress. In 2003, all American taxpayers received a reduction in their income tax rates.
Are dividends considered ordinary income?
Dividends are considered ordinary by default unless they meet special requirements put in place by the IRS. Ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at the lower capital gains rate. Dividends earnings fall into two general categories: qualified or nonqualified (ordinary) dividends.
What is an ordinary dividend?
An ordinary dividend is a dividend that is not eligible for capital gains tax. How Does an Ordinary Dividend Work? For example, let’s assume that John Doe holds 10,000 shares of Company XYZ stock, which pays $0.20 per year in dividends. In total, John Doe receives 10,000 x $0.20 = $2,000 per year in dividends from Company XYZ.
Are ordinary dividends taxed?
However, “ordinary dividends” (or “nonqualified dividends”) are taxed at your normal marginal tax rate. But on a more fundamental level: What exactly is a qualified dividend, and how do we know if the dividends paid by the stocks in our portfolios are qualified?