Key Takeaways:
- Dividends received by American investors are classified into qualified dividends and ordinary dividends.
- The classification of dividend types is based on the IRS criteria. One of these criteria is the holding period of the stocks by the investor.
- The category into which the payments are classified affects the tax rate. The marginal tax rate on nonqualified dividends is 37%. The maximum capital gains rate for qualified dividends is 20%. The individual tax rate depends on the incomes of taxpayers.
- Payments from foreign companies may also qualify for favorable tax treatment in certain cases.
This article explains the difference between ordinary and qualified dividends.
Table of Contents
What Are Dividends?
Dividends are a portion of a company’s earnings distributed among shareholders. They are typically regular payments that can be made quarterly, monthly, or annually.
Companies most often pay cash dividends. However, stock dividends are also allowed. In this case, investors receive additional securities instead of cash.
Qualified Dividend Tax Rates
For an investor, the key difference between ordinary dividends and qualified dividends comes down to the tax rate.
The table below shows the qualified dividend tax rates for 2025 based on the taxpayer’s income and filing status. The threshold values for moving to the next category have been increased compared to the 2024 tax year. This adjustment has been made to take account of inflation.
| Tax rate | Single | Married filing jointly | 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 to $533,400 | $96,701 to $600,050 | $48,350 to $300,000 | $64,751 to $566,700 |
| 20% | $533,401 or more | $600,051 or more | $300,001 or more | $566,701 or more |
The specified rates apply to capital gains of all categories except for taxable income from the sale of collectibles and qualified small business stock. They also do not apply to unrecognized gains on Section 1250 real property.
History of Qualified Dividends
The distinction between qualified vs non qualified dividends first emerged as a result of the 2003 tax cuts. Signed by George W. Bush, the law reduced the marginal rate on qualified dividends to 15%. Depending on their income, investors were required to pay either 5% or 15%.
In 2005, another law was enacted that lowered the rate to 0% for individuals with low incomes. In 2012, the maximum long-term capital gains tax rate was increased to 20%.
The goal of these laws was to create a favorable tax treatment and an incentivized economic growth. The government also aimed to provide an incentive for distributing profits in the form of rewards for shareholders. Prior to 2003, most companies preferred to conduct stock buybacks or retain undistributed profits on their balance sheets.
As a result, long-term holds in stocks have become a popular income investing strategy. Even growth companies, such as tech stocks like Apple and Nvidia, now pay dividends.
What Is a Qualified Dividend?
The answer to the question of what is the difference between qualified and non qualified dividends is simple. Qualified dividends are ordinary dividends from a public company that meet the requirements set by the Internal Revenue Service (IRS). Meeting these requirements allows for favorable tax treatment.
Therefore, the key factor in the distinction between qualified vs ordinary dividends is tax savings. Qualified dividends are subject to capital gains tax rates, while nonqualified dividends are taxed at the regular income tax rate.
A key criterion that determines whether dividends will be considered qualified for a particular investor is the holding period. For common stock shares, this period is at least 61 days within a 121-day period that begins 60 days before the ex-dividend date.
Note! The classification of ordinary vs qualified dividends occurs for each payment individually, rather than within the context of a tax year.
Qualified Dividend Requirements
The classification of qualified dividends vs. ordinary dividends is influenced by the fulfillment of IRS requirements. For an investor to receive favorable tax treatment, three conditions must be met:
- The payment must be received from a U.S. company that does not fall into the category of issuers whose dividends cannot be considered qualified.
- The investor must have held the share for the required period. For common stocks, this period is 61 days or more within a 121-day period. Counting does not start on the day of the stock purchase. The holding period that counts begins 60 days before the ex-dividend date (the record date on which the investor must be included on the company’s books in order to receive dividends). Preferred stocks must be held for more than 90 days within a 181-day period.
- The position must not have been hedged. If an investor uses options and other derivatives on the stock for which they received dividends, they lose the right to the tax reduction.
Dividend payments from a foreign company may also be taxed at long-term capital gains rates if there is a tax treaty with the issuing country. In addition, the company must have a presence in the U.S., and its shares must be traded on American exchanges.
Important Note on Purchase Timing
To receive the dividend, you need to purchase the stock at least one day before the ex-dividend date.
What Are Ordinary Dividends?
Ordinary dividends are all dividends that are not considered qualified. They are treated as ordinary income and are subject to the regular income tax rate. For investors in the highest tax bracket, this rate is 37 percent, while the maximum capital gains tax rate is 20 percent.
Therefore, for high-income individuals, it is extremely important to understand the difference between qualified dividends and ordinary dividends.
Investments That Don’t Pay Qualified Dividends
The special tax treatment does not apply to dividends received from:
- REITs (real estate investment trusts);
- MLPs (master limited partnerships);
- money market funds;
- tax-exempt companies;
- passive foreign investment companies;
- any stocks for which hedging is used with puts, call options, short sales, and other methods.
Favorable tax treatment does not apply to special one-time dividends from any companies. The tax benefit cannot be applied to payments made under an employee stock-option plan.
The distinction between non qualified vs qualified dividends is only relevant for taxable brokerage accounts. If you use an IRA, for example, qualified and ordinary dividends are not taxed. An investor may not even receive a Form 1099-Div.
Additional Taxation for High-Income Investors
The U.S. tax code includes an additional net investment income tax (NIIT). To determine this tax, net investment income (NII) or modified adjusted gross income (MAGI) is used. The calculation is based on the lesser of the two amounts. The threshold amounts are:
- $200,000 for single filers;
- $250,000 for married filing jointly.
Higher-income taxpayers must pay a net investment income tax of 3.8% on their investment gains.
Mutual Funds and Qualified Dividends
When it comes to mutual funds, the distinction between qualified versus non qualified dividends depends not only on the investor’s holding period but primarily on the fund’s holding period. The fund must hold a security unhedged for more than 60 days in order to receive qualified dividends.
These funds will then distribute the income to their investors. If an individual has held the applicable share in the mutual fund for more than 60 days, they will be eligible to pay tax at the lower capital gains rate.
If the fund does not meet these requirements, then the dividends will be considered ordinary income. The lower tax rate will not apply, even if the investor held the shares for the required period.
How to Identify If Your Dividends Are Qualified
Online trading platforms and brokers provide investors with IRS Form 1099-DIV. Box 1a reports all dividends received, while Box 1b shows the amount of qualified dividends.
The situation is more complex when it comes to income planning. In general, all dividends from U.S. common stocks can be considered qualified. However, this only applies to corporations. In the case of foreign companies and alternative investments (such as BDCs), it is advisable to consult a tax professional.
Tax Planning Strategies for Dividend Investors
An important component of tax planning is asset location. The distinction between qualified vs unqualified dividends is only relevant for taxable brokerage accounts.
Tax-advantaged accounts offer complete tax exemption or defer tax payments, making them suitable for purchasing stocks whose dividends are taxed at income tax rates.
An example of a tax-efficient investment strategy (not personalised investment advice) might include:
- buying stocks that generate qualified dividends in a taxable brokerage account;
- real estate investment through REITs and purchasing money market funds in an IRA or 401(k).
Tax-advantaged accounts are not suitable for all investment objectives. To effectively plan an investment strategy for growing personal finance, it is essential to understand what is difference between ordinary and qualified dividends.
The Bottom Line
Payments from most American companies can be recognized as qualified dividends. To pay tax at the capital gains rate, you must hold the common stock for at least 61 days during a 121-day period. This period begins 60 days before the ex-dividend date. For preferred stocks, these holding periods increase to 91 and 181 days.
Individual investors who have difficulty determining whether they will receive a tax break may benefit from consulting a financial professional. Investing involves risk. Tax optimization allows for a more favorable risk-return ratio for the investor.
FAQ
Do I report total ordinary dividends or qualified dividends?
Form 1099-DIV shows two amounts: total ordinary dividends vs qualified dividends. The first is reported in Box 1a, while the second is reported in Box 1b. Both amounts should be reported on Form 1040 in Boxes 3b and 3a, respectively.
How much of qualified dividends are tax free?
For long-term capital gains, the tax rate is 0% if the investor’s total taxable income is less than $48,350 (for a single filer) or $64,750 (for head of household).
Do you subtract qualified dividends from ordinary dividends?
The investor should transfer the information about received dividends from 1099-DIV to Form 1040 (tax return) without changes. However, when calculating taxes, the amount of ordinary dividends will be reduced by the amount of qualified dividends.
Article Sources
- Shackelford, D. A. (2021). “The tax environment facing the wealthy: Rates, asset location, and evasion.” American Economic Review, 90(2), 342-346.
- Graham, J. R. (2020). “Taxes and corporate finance: A review.” The Review of Financial Studies, 16(4), 1075-1129.
- Dhaliwal, D., Krull, L., & Li, O. Z. (2019). “Did the 2003 Tax Act reduce the cost of equity capital?” Journal of Accounting and Economics, 43(1), 121-150.
- Hanlon, M., & Hoopes, J. L. (2022). “What do firms do when dividend tax rates change? An examination of alternative payout responses.” Journal of Financial Economics, 114(1), 105-124.
- Desai, M. A., & Jin, L. (2021). “Institutional tax clienteles and payout policy.” Journal of Financial Economics, 100(1), 68-84.
