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Understanding Qualified and Ordinary Dividends
Buying low and selling high isn’t the only way to profit from your investments. Many investments also pay dividends to their shareholders, providing periodic income that you can spend, save, or reinvest. However, where there’s income, there are usually taxes. Dividends are considered taxable income, and they’re taxed differently depending on the type of dividend you receive. Here’s what you need to know about dividends and your taxes.
What Are Qualified and Ordinary Dividends?
Stocks, mutual funds, and other investments may pay dividends to their shareholders monthly or quarterly, in cash or shares. For tax purposes, dividends are divided into two types: qualified and ordinary.
Qualified dividends include those from most domestic companies and many qualified foreign companies listed on major U.S. exchanges. The IRS issues guidelines on qualified dividends, including a requirement that you hold shares for at least 61 days of the 121 days surrounding the date of purchase required to receive a dividend for the period.
Ordinary dividends may include those from some foreign companies, real estate investment trusts, tax-exempt organizations, and other non-qualifying entities under IRS rules.
Qualified and ordinary dividends are taxed differently, but otherwise are largely alike. If you’re unsure which type of dividends you’ve received, check Form 1099-DIV or Schedule K, which will be sent to you at the end of January if you’ve earned $10 or more in income from an investment. These forms show your dividend income as either qualified or ordinary dividends, so you can report them appropriately on your tax return.
How Are Qualified Dividends Taxed?
Qualified dividends are taxed at your long-term capital gains rate, which is typically lower than your regular tax rate. Long-term capital gains rates are determined by your adjusted gross income and filing status. Here are the long-term capital gains tax rates for 2023:
| Rate | Single | Married, Filing Jointly | Married, Filing Separately | Head of Household |
|---|---|---|---|---|
| 0% | Up to $44,625 | Up to $89,250 | Up to $44,625 | Up to $59,750 |
| 15% | $44,626 – $492,300 | $89,251 – $553,850 | $44,626 – $276,900 | $59,751 – $523,050 |
| 20% | Over $492,300 | Over $553,850 | Over $276,900 | Over $523,050 |
For example, if you make $100,000 a year and receive $10,000 in qualified dividends in 2023, you’ll be taxed $1,500.
How Are Ordinary Dividends Taxed?
Ordinary dividends are taxed at the same rate as short-term capital gains: the top personal tax rate you pay. To find your top tax rate, find the bracket with your adjusted gross income on the charts below.
| Tax Rate | Unmarried | Head of Household | Married Filing Separately | Married Filing Jointly |
|---|---|---|---|---|
| 10% | $0 – $11,000 | $0 – $15,700 | $0 – $11,000 | $0 – $22,000 |
| 12% | $11,001 – $44,725 | $15,701 – $59,850 | $11,001 – $44,725 | $22,001 – $89,450 |
| 22% | $44,726 – $95,375 | $59,851 – $95,350 | $44,726 – $95,375 | $89,451 – $190,750 |
| 24% | $95,376 – $182,100 | $95,351 – $182,100 | $95,376 – $182,100 | $190,751 – $364,200 |
| 32% | $182,101 – $231,250 | $182,101 – $231,250 | $182,101 – $231,250 | $364,201 – $462,500 |
| 35% | $231,251 – $578,125 | $231,251 – $578,100 | $231,251 – $346,875 | $462,501 – $693,750 |
| 37% | $578,125 or more | $578,101 or more | $346,876 or more | $693,751 or more |
Using our earlier example—you’re earning $100,000 in regular income and $10,000 in dividends—the short-term capital gains tax rate (for ordinary dividends) would be equal to your top personal tax rate: 24% in 2023. In this scenario, you would owe $2,400 in taxes on $10,000 in dividends—or 60% more in taxes than you would owe for qualified dividends.
Additional Tax for High-Income Taxpayers
There’s an added wrinkle for high-income taxpayers. If your modified adjusted gross income exceeds the following thresholds and you have income from dividends, capital gains, and other investment-related activities, you may be subject to an additional 3.8% tax on your net investment income.
| Filing Status | Threshold Amount |
|---|---|
| Single or Head of Household | $200,000 |
| Married, filing jointly | $250,000 |
| Married, filing separately | $125,000 |
How to Minimize Your Dividend Taxes
Whenever you make money, in dividends or otherwise, you’re likely to be on the hook for taxes. However, you may be able to minimize your tax burden by considering one of the following strategies:
- Choose qualified dividends over ordinary dividends: Where you can, look for investments that pay qualified dividends instead of ordinary dividends. Qualified dividends are not uncommon, so finding these investments shouldn’t be too difficult. If you have investments that pay ordinary dividends, be sure to factor in a higher tax rate when you’re evaluating performance.
- Use tax-advantaged accounts: Earnings on investments held in a Roth IRA are tax-free. As long as you follow guidelines on qualified distributions, withdrawals from a Roth IRA are tax-free as well. Similar tax advantages apply to 529 education accounts, which can be used to save for college or private school tuition.
- Keep your regular income low: Keeping your marginal adjusted gross income below NIIT thresholds can save you 3.8% by helping you avoid this additional tax. Keeping your income in the 0% range for long-term capital gains could save you from paying taxes on your dividends altogether. If your adjusted gross income is close to the margins, it may be worth looking for additional deductions (retirement contributions, medical expenses, and mortgage interest are a few examples) to keep your tax liability low.
The Bottom Line
With the help of your 1099-DIV, reporting dividend income on your taxes isn’t especially difficult. But if you’re confused about how your dividends are characterized, or how dividend income is affecting your taxes, you may want to consult your investment advisor or tax professional. They can help you ensure that your income is reported correctly and may suggest strategies for keeping your taxes to a minimum.
For any mortgage-related needs, feel free to call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with confidence.
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