Ordinary dividends are part of the profits that a public company distributes to its shareholders. This income must be reported to the Internal Revenue Service, regardless of whether it comes from preferred or common stock shares.
Taxes depend on two factors. The first is the income level of the investor. The second is the category into which the payment falls. Nonqualified dividends are taxed at income tax rates, while qualified dividends are taxed at capital gains tax rates. If an individual investor’s income is $48,350 or less, their tax rate is 0%.
This article explains what is a non-qualified dividend and what makes a dividend qualified.
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Key Takeaways
- A qualified dividend is an ordinary dividend for which certain IRS requirements have been met.
- Dividends are considered qualified if the investor held the stocks for the required holding period. There are also restrictions on the type of issuer. The stocks must be issued by a U.S. corporation or a qualified foreign corporation.
- If the requirements are met, dividends are taxed at capital gains tax rates (with a maximum of 20%). This allows for savings, as income tax rates are higher. The maximum tax rate in this case is 37%.
Requirements for Qualified Dividends
The answer to the question of what is a non-qualified dividend is simple. They are any dividends that do not meet three requirements:
- The income must be received from a U.S. corporation or a qualified foreign corporation.
Important! Any money paid by REITs, MLPs, and some other organisations can only be nonqualified dividends.
- The payment must be a regular dividend. The benefits do not apply to capital gains distributions, substitute payments, dividends from trust preferred stocks issued by banks, etc.
- The investor must have held the stocks for at least 61 days during a 121-day period that begins 60 days before the ex-dividend date.
For a foreign corporation to be considered qualified, the following conditions must be met:
- the company must be registered in the U.S.;
- the country of the company’s origin must have a tax treaty in place;
- the company’s stocks must be readily tradable on U.S. stock exchanges.
The third point in defining what qualifies as a qualified dividend is the minimum holding period during which the investor must own the common stocks. This period is 61 days within a specified 121-day period, which begins 60 days before the ex-dividend date (which coincides with the record date).
Let’s provide a practical example of what is considered a qualified dividend. Suppose the record date is set for 04/02/2025. In this case, the holding period starts on 02/01/2025 and ends on 06/02/2025.
If an investor buys the stock on 02/03/2025 and sells it on 04/07/2025, they will have held the security for 63 days. This is in excess of the required 61-day period, meaning they are eligible for the reduced tax rate. If the investor buys the stock on 03/03/2025 and sells it on 04/07/2025, the holding period is 35 days. Thus, the individual will therefore receive nonqualified dividends.
Holding Periods for Other Investments
The above holding periods apply only to common stocks. For preferred stocks, the holding period is 91 days or more within a 181-day period. This period begins 90 days before the record date for beneficial owners.
For shareholders of mutual funds, the same holding period applies as for holders of common stocks. However, funds pay qualified dividends only if they themselves have met the requirement of holding security that is unhedged for at least 61 days.
For example, if a mutual fund held Apple stocks for only 50 days during the required period, then both the fund and its shareholders will receive non-qualified dividends from that company.
Capital Gains Tax Rates for Qualified Dividends
All dividends are reported on IRS Form 1099-DIV, Section 1a. Section 1b includes the portion of the amount that meets the requirements for qualified dividends. That is, the funds received from a U.S. corporation or a qualifying foreign company, provided that the stocks were held for the required period.
For capital gains, tax rates of 0%, 15%, or 20% are generally used. The rate that will apply in each specific case depends on the investor’s income and filing status.
However, there are exceptions where capital gains are taxed at a higher rate (up to 28%). These include income from the sale of collectibles, qualified small business stock, unrecaptured gains reported in Section 1250 real property, and others.
Qualified Dividends vs. Ordinary Dividends
The long-term capital gains rates applicable for the 2025 tax year are shown in the table below. Readers can determine their individual rate based on their taxable income and filing status.
| Tax rate | Singles | Joint-married filers | Married filing separately | Head of household |
| 0% | up to $48,350 | up to $96,700 | up to $48,350 | up to $64,750 |
| 15% | $48,351 – $533,400 | $96,701 – $600,050 | $48,350 – $300,000 | $64,751 – $566,700 |
| 20% | $533,401 or more | $600,051 or more | $300,001 or more | $566,701 or more |
The ordinary income tax rate ranges from 10% to 37%.
There are also other tax implications. For example, if the net investment income (NII) or modified adjusted gross income (MAGI) exceeds a certain amount, an additional 3.8% tax is imposed. For single filers and heads of household, the threshold is $200,000. For married filing jointly, it is $250,000.
Therefore, it is advisable for high-income individuals to hold dividend stocks in tax-advantaged accounts, such as a 401(k) or IRA.
Examples of Qualified Dividends
Let’s provide examples of dividends that are qualified. Suppose an investor owns shares of Apple and Enbridge. He has met the requirements regarding the holding period.
The dividends from Apple will be considered qualified because the payment:
- comes from a U.S. corporation;
- represents a regular quarterly dividend (for example, in 2024, Apple paid shareholders $0.25 per share).
Enbridge is a Canadian corporation. Despite this, its dividends can also be recognized as qualified because all the requirements are met:
- the payments are regular;
- the company’s branch is registered in the U.S.;
- there is a tax treaty with Canada;
- Enbridge shares can be purchased on U.S. stock exchanges.
What Types of Investments Typically Qualify
Most dividends from U.S. corporations can be considered qualified. A key consideration is the status of the corporation. Examples of what is a non-qualified dividend include dividends paid by:
- real estate investment trusts (REITs);
- master limited partnerships (MLPs);
- tax-exempt companies;
- credit unions;
- banks on trust preferred stock;
- any companies within an ESOP, and others.
In addition, liquidation dividends and payments made not from the profits of financial institutions cannot be recognized as qualified ones.
For foreign companies, there are additional requirements. First and foremost is the trading of shares on U.S. exchanges. Furthermore, the issuer’s home country must have a tax treaty with the U.S. A separate issue is the passive foreign investment company. Dividends paid by such organizations cannot be recognized as qualified.
Hedging a position with short sales or puts and call options on the underlying stock disqualifies the right to a reduced tax rate. Only dividends from unhedged securities can be considered qualified.
Advantages of Qualified Dividends
The advantage of qualified dividends is the reduction of the tax burden. Such an income is taxed at the long-term capital gains tax rate.
To better understand what is qualified dividend income and what benefits it provides, let’s consider two investors. Suppose they have the same income level (the tax bracket is $40,000) and receive dividends of $1,000.
The investor who held the stocks for more than 61 days during the required period will pay no tax on the dividends. The long term capital gains tax rate for him is 0%.
The investor who held the stocks for less than 61 days during the required 121 day period will pay $120. The ordinary income tax rate will be 12% on the specified annual income.
The purpose of introducing favorable tax treatment is to encourage people to hold stocks for the long term. It also acts as an incentive for the company’s board to reward shareholders by paying dividends, making the stocks attractive to long-term investors.
How to Identify Qualified Dividends on Tax Forms
At the end of the year, investors receive IRS Form 1099-DIV from their broker or online trading platform. Box 1a shows the total amount of dividends. Box 1b shows the amount of those that are qualified.
Tax Planning Strategies for Dividend Investors
Reinvesting dividend income is one way to create long-term wealth. Tax planning helps to make this process more efficient. This includes not only reducing the tax burden by receiving qualified dividends in taxable accounts.
Tax-deferred accounts, such as an IRA, play an important role in wealth creation. Dividends from stocks held in such accounts are not taxed in the year they are received. Another option is a Roth IRA or Roth 401(k). These can be used to avoid taxes on financial gains. As a result, combined with the ‘magic of compounding’, the total return on investments can be significantly higher over decades.
The Bottom Line
Qualified dividends provide individual investors with significant tax breaks. Most payments from American companies meet the requirements of the legislation. They are eligible for capital gains tax rate.
The main task for the investor is to ensure that they have held the stock for 61 days or more during the required period. The qualifying period is 121 days, starting 60 days before the ex-dividend date.
