How Are Ordinary Dividends Taxed

What are Ordinary Dividends?

Ordinary dividends represent the distribution of a company’s profits to its shareholders after an accounting period. For shareholders, dividends are one of the two primary returns they get on their investment. There are other types of dividends as well, such as special dividends. However, ordinary dividends are more common. Shareholders can expect ordinary dividends after regular intervals based on a company’s history.

For the IRS, dividends may fall into either qualified or non-qualified dividends. The classification is crucial to determine the tax that shareholders have to pay on their income. It is because the taxation procedure for each type of dividend will differ. Therefore, it is crucial to understand what qualified and non-qualified ordinary dividends are.

What are Qualified and Non-qualified Dividends?

Qualified ordinary dividends represent dividends that meet some criteria specified by the IRS. Any distribution of profits from companies that meets the following criteria will be considered qualified dividends.

  • The dividend must be from an American company or a qualifying foreign company.
  • The dividend must not be listed as an unqualified dividend with the IRS, under IRS publication 550.
  • Shareholders must have held it for at least 60 days for common stock, 90 days for preferred stock, and 60 days for dividend-paying mutual funds.

Qualified dividends get their name because these qualify for long-term capital gains tax rates. Any distribution of profits that does not meet the above criteria will be considered non-qualified. An ordinary dividend is not a part of the qualified dividend. Therefore, taxation procedures for both will differ.

How are Qualified Dividends taxed?

Once shareholders can differentiate between the classification of their dividends, they can also determine their taxation treatment. For qualified dividends, investors have to pay tax at 0%, 15%, and 20% depending on their long-term gains tax bracket.  There are some specified rules for each tax percentage. For the 0% tax rate, shareholders can qualify if:

  • Their income is less than $40,000, and they are single.
  • Their income is less than $80,000, and they are married and file a joint return with their spouse.
  • Their income is less than $53,600, and they qualify as head of household.

Shareholders have to pay a 15% tax on their qualified dividend if they exceed the above limit up to:

  • $441,449 for single individuals.
  • $496,599 for a married couple
  • $469,049 for the head of households.

Shareholders who exceed the above limits must pay taxes at 20%. For other types of dividends, shareholders have to pay the same rates as their other income.

How Are Ordinary Dividends Taxed?

The taxation on ordinary dividends depends on the tax bracket in which shareholders are. The IRS provides these tax brackets for income tax each year. Since ordinary dividends qualify in these brackets, shareholders must pay taxes by adding these dividends to their total income. The taxes that they must pay include 10%, 12%, 22%, 24%, 32%, 35% and 37%.

Therefore, shareholders may have to pay at least 10% and at most 37% tax on their ordinary dividends. However, the high rate is for the highest tax bracket. The IRS has several limits for shareholders to qualify in each category. These brackets differ for single individuals, married couples, and heads of households similar to qualified dividends.

Conclusion

Ordinary dividends include any income from the distribution of a company’s profits that shareholders get. Shareholders must differentiate between qualified and non-qualified dividends. Qualified dividends have specific tax rules and are taxed based on the long-term gains tax bracket. For ordinary dividends, shareholders have to pay tax according to their income tax bracket.

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