- Ordinary dividends are a part of the company’s profits that are distributed to its shareholders as periodic distributions. This rewards equity ownership in the company.
- Dividend income is categorised into two distinct classifications: qualified and nonqualified dividends. Qualified dividends are regular payments that meet the IRS’s requirements.
- Dividends are a form of taxable income. The concept of ‘qualified dividends’ and their associated tax benefits were introduced to encourage long-term stock investments.
In this article, we will answer the question ‘What is an ordinary dividend?’, and examine the ordinary dividends tax rate implications for investors.
Table of Contents
Understanding Ordinary Dividends vs Qualified Dividends
The IRS criteria that allow regular payments to be classified as qualified dividends include two types of requirements. The first relates to the source of the payments, which must be from American companies that pay corporate tax, or from qualified foreign companies.
The second IRS requirement relates to the holding period requirements:
- A minimum of 61 days within a 121-day period is required for common stocks. This period begins 60 days before the ex-dividend date.
- The holding period for preferred stocks increases to 91 days within a 181-day period starting 90 days before the ex-dividend date.
- The holding period for mutual fund shares is 61 days. However, dividend payments will only be recognised as ‘qualified’ if the fund itself meets the IRS requirements.
Proper dividend classification is essential. This is because qualified dividends benefit from a preferential tax treatment. These are taxed at long-term capital gains rates.
A common question is: ‘What is ordinary dividends?’ From a tax code perspective, these are payments that do not fall within the qualified dividend tax classification and are therefore subject to income tax as ordinary income.
Tax Treatment of Ordinary Dividends
A common question from novice investors is: ‘Are ordinary dividends taxable?’ Nonqualified dividends are subject to the ordinary income tax rate.
The federal income tax rates range from 10% to 37%, depending on the investors’ tax brackets. These rates apply to all forms of regular income taxation, including wage taxation and interest from deposit certificates.
The total ordinary dividends received from individual securities and mutual funds must be reported on IRS Form 1040. According to tax filing requirements, Schedule B must be completed if the annual dividend income exceeds $1,500.
Important: the marginal tax rate on qualified dividends is 20%. Therefore, ordinary dividends are extremely unfavourable for high-income investors due to the 37 percent maximum rate.
Types of Investments That Pay Ordinary Dividends
Non-qualifying investments include annuities and precious metals, among others. This list does not include dividend-paying securities. However, in some cases, taxable distributions will not be recognised as qualified dividends, regardless of the holding period. This occurs if the distribution comes from the following investment types:
- tax-exempt organizations, such as REITs (real estate investment trusts);
- money market funds;
- credit unions;
- mutual funds (if the capital gain distribution or interest and ordinary dividends received by the fund);
- foreign companies that do not meet IRS requirements.
Payments made within ESOPs, special dividends, and liquidation dividends are classified as ordinary dividends.
H2: Form 1099-DIV and Tax Reporting
Investors are provided with dividend reporting in the form of a Form 1099-DIV. Box 1a lists the total amount of ordinary dividends received by the investor for the tax year. The amount that qualifies for the lower capital gains rate in accordance with IRS reporting requirements is shown in Box 1b.
The 1099-DIV form is used for tax reporting purposes. According to IRS reporting requirements, brokerages and management companies must provide dividend documentation by 31 January of the following year.
Investors use Form 1099-DIV when doing their tax preparation. However, if they do not receive it for any reason, they must still include information about paid dividends in their annual tax documents. This information can be found in the brokerage reporting for the year.
Historical Changes in Dividend Tax Rates
Here is a brief dividend tax history. The first tax benefits were introduced with the passing of the Jobs and Growth Tax Relief Reconciliation Act 2003 (JGTRRA). Over the next two years, qualified dividends were taxed at capital gains tax rates ranging from 5% to 15%, depending on the investor’s income.
The Tax Increase Prevention and Reconciliation Act 2005 (TIPRA) extended these tax benefits until 2010. For low-income individuals, the long-term capital gains tax rate was reduced from 5% to 0%. These legislative provisions were later extended for another two years.
The American Taxpayer Relief Act 2012 made the lower qualified dividend rates permanent. The tax legislation also introduced a new long-term capital gains tax rate of 20% for high-income taxpayers.
Understanding Ordinary Dividends Tax Rate: Calculating Tax Impact on Ordinary Dividends
A common question: ‘How are ordinary dividends taxed?’ Here is an example of a tax calculation. The amount of federal taxes you pay is dependent on the income tax brackets you fall into. The marginal tax rate is determined by income level and filing status.
Suppose a single investor earned $400,000 in one year. They also received $20,000 in dividend income. The tax rate on ordinary dividends is 35%. The qualified dividend tax rate (long-term capital gains) is 15%. Therefore, the investor’s tax liability would be $7,000 or $3,000 respectively.
When investing, it is important to consider not only the dividend yield of the stock, but also the individual after-tax returns. U.S. federal income taxes are progressive. In practice, it is necessary to calculate the effective tax rate in order to determine the investment returns.
Although dividends from foreign corporations may be recognized as qualified dividends, withholding tax is applied to such income at source. However, the foreign tax paid can be offset against a foreign tax credit (FTC).
Managing the Ordinary Dividends Tax Rate: Strategies for Managing Ordinary Dividend Taxes
One way to achieve tax efficiency through dividend tax management is to choose the right asset location. Tax-advantaged accounts such as Roth IRA and Roth 401(k) are not subject to tax rate for ordinary dividends.
However, there are many additional nuances. Therefore, it is advisable to consult a personal finance advisor or tax planning specialist. They can help you determine the optimal portfolio allocation between taxable accounts and retirement accounts.
Ordinary Dividends in Investment Planning
When developing an investment strategy, it is important to consider more than just dividend yield. Cash flow planning includes:
- forecasting total return;
- risk assessment;
- tax considerations in line with investment objectives.
It is possible to make portfolio planning easier when the aim is to generate future retirement income, and this can be achieved by using accounts that have tax advantages.
When income investing in taxable accounts, it is important to understand how ordinary dividends are taxed.
The Bottom Line
Dividend taxation affects investment returns. Financial planning of dividend income is impossible without taking tax considerations into account. Understanding the ordinary dividends tax rate, which ranges from 10% to 37% depending on income level, is crucial for calculating after-tax returns.
Despite the high tax burden, ordinary dividends can form an important part of an income portfolio. However, investors need to ensure they correctly assess the overall investment returns when selecting assets.
FAQ
What is the ordinary dividend?
Ordinary dividends are regular distributions paid out of a company’s net earnings.
Do I pay taxes on ordinary dividends?
There is a tax on ordinary dividends. Payments that do not meet IRS requirements are subject to regular income tax rates.
What is the difference between ordinary and non qualified dividends?
Both terms are generally used to refer to dividends that are taxed as ordinary income.
How do I report ordinary dividends?
Information about ordinary dividends should be listed in Box 3b of the investor’s tax return. If their total exceeds $1,500, Schedule B must also be completed.
Article Sources
- Internal Revenue Service (2024). “Publication 550: Investment Income and Expenses (Including Capital Gains and Losses).” Official IRS guidance distinguishing qualified versus ordinary dividends for tax purposes.
- Internal Revenue Service (2024). “Topic No. 404, Dividends.” Federal tax authority’s comprehensive explanation of dividend classification and tax treatment differences.
- Kiplinger Tax Services (2020). “Qualified Dividends vs Ordinary Dividends: Academic Tax Analysis.” Professional tax research analyzing the 2003 tax law changes creating qualified dividend classifications.
- Accounting Insights (2025). “Qualified vs Ordinary Dividends: Key Differences and Tax Implications.” AccountingInsights.org, January 2025. Comprehensive academic-style analysis of dividend classification under Internal Revenue Code and GAAP standards.
