What are Qualified Dividends?
Qualified dividends are dividends that are labeled as ordinary, and these meet all the required criteria to be taxed at CG (capital gains) tax rates and not at higher income tax rates on ordinary or non-qualified. These are paid by a qualifying international entity or a U.S. company. They are also acknowledged as a corporate distribution that meets specific criteria that are set by the IRS for being eligible for receiving CG treatment.
Let’s discuss the following requirements.
- Stakeholders must fulfill specific requirements for being eligible to be taxed at lower capital gain rates. The first and foremost requirement would make it necessary for stakeholders to abide by a smaller period of holding. In case of common stock, share needs to be held for 60 days and above during the 120 day time period, which commences 60 days before the ex-dividend date.
- In cases of preferred stock, shares need to be held for 90 days and above during the 180 time period, which begins 90 days before the ex-dividend date of that particular stock. It means if Microsoft or Apple pays a dividend to an investor and they meet all the criteria with respect to holding period. Such dividends will be regarded as qualified, and if the holding period requirements are not fulfilled, then the dividend will be considered as unqualified and will be, therefore, taxed at an ordinary income tax rate.
How to Calculate Qualified Dividends?
It can be calculated in the following steps-
- In the first step, one must determine and sum up the number of shares that are fulfilling all the requirements about the holding period.
- In the next step, one must determine the portion per share of any of his choice of dividends.
- For every dividend, the above evaluated two amounts must be multiplied together for calculating the number of qualified dividends.
Real Life Example
In a company, a dividend of $0.16 per share is paid. However, only 50 percent of the $0.08 dividend per share was reported as qualified dividends. The owner of the dividend held a total of 10,000 shares, out of which only 7,000 shares are held for the required holding period. Calculate the amount of eligible, qualified dividends for the owner of the dividend-
The number does not fund shares * dividend per share = Actual amount of qualified dividends.
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Therefore, 7,000 * $0.08 = $ 560
It means that only $ 560 is supposed to be taxed at favorable rates while the remaining dividends would be taxed at ordinary income tax rates.
How to Reduce your Tax on Qualified Dividends?
- The best way to reduce taxes on dividends is by putting dividend earning stocks in retirement accounts. The best part of retirement account i.e, that the money earned will remain free from tax implications. However, one will still feel the need to pay taxes prior or later to the contribution of money, but will not have to pay taxes as savings grow for the retirement account.
- One must select a retirement account based on his or her requirements. Roth IRA and 401(k) plan are two commonly used options. Roth IRA takes after-tax money while a 401(K) plan is sponsored by the employer where he might take pre-tax money while the employee will have to pay income tax at the time of withdrawal of funds.
Qualified vs. Ordinary Dividends
- When it comes to tax treatment, the former is seen to be taxed at long term capital gain rates, which are way lower in comparison to ordinary income tax rates. Whereas ordinary dividends, as the name suggests, are taxed based on ordinary income tax rates.
- The minimum ordinary income tax rate is 10 percent, whereas, for a qualified dividend tax rate, the same is 0 percent.
Qualified vs. Non Qualified Dividends
- Qualified and non-qualified are types of ordinary dividends. Qualified dividends are taxed at long term capital rates while non-qualified are taxed based on ordinary income tax rates.
- Non-qualified are taxed at a standard tax rate in the case of individuals since these fail to qualify for a lower level of tax preference. Qualified rates are way lower than the regular income tax rate applied to non-qualified or ordinary dividends.
- Examples of non-qualified dividends are dividends paid by REITs (real estate investment trusts), MLPs (master limited partnerships), tax-exempt entities, dividends that are paid on ESO (employee stock options), money market accounts or savings. Dividends received in IRA, and one-time (special) dividends are also such examples.
Capital gain tax is normally lower than the ordinary income tax rate. This reason is why these are most preferred since it allows investors to reduce their tax burden. The dividend that comes from an American entity or a qualifying international company which is not remarked as an unqualified dividend with the IRS and meets the required holding period can only be deemed as a qualified dividend.
Dividends paid by REITs (Real estate investment trusts), MLPs (Master limited partnerships), tax-exempted companies, dividends that are paid on ESO (employee stock options), money market accounts, or savings, etc. are few types of non-qualified dividends.
This article has been a guide to what are qualified dividends and its definition. Here we discuss how qualified dividends work along with practical examples and calculations and ways to reduce tax on it. You can learn more about financing from the following articles –