Qualified vs Ordinary Dividend

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Difference Between Qualified and Ordinary Dividend

The key difference between Qualified and Ordinary Dividend is that the qualified dividend is one where dividend income is chargeable to tax at lower rates than the normal tax rate. In contrast, the ordinary dividend income is chargeable to tax at the normal tax rate applicable to such shareholders.

A Dividend is a part of the profit of the organization. The company distributes it among the shareholders regarding the number and kind of shares, like equity or preference sharesPreference SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more acquired by the holders. Many corporations distribute a regular dividend at a specific frequency like a quarterly, half-yearly, and yearly basis. The quarterly payment of dividends is quite famous among the corporations in the United States. Once the dividend is distributed, it is treated as taxable income in the hands of shareholders. Therefore, it is taxed as per their classification either as Qualified or Ordinary Dividend.

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What is a Qualified Dividend?

A dividend taxed under Capital Gain Tax Rate is a Qualified Dividend. This is because the tax rate on capital gain is generally lower than the normal income tax rate, and hence it helps the investors save their money by reducing tax payments.

  • The investors who are covered under the 0% to 15% income tax slab have to pay 0% tax on their Qualified Dividend Income.
  • Those covered under more than 15% but less than 39.6% have to pay 15% tax on their Qualified Dividend Income.
  • The Qualified Dividend Income taxed 20% for individuals who pay normal income tax with a 39.6% slab.

However, the following criteria must meet to treat the dividend as a qualified dividend and get the benefits of lower tax payments on the dividend income earned;

  1. Holding Period: In the case of common stock, the dividend receiver must have owned the stock for more than 60 days during 121 days, starting from 60 days before the the ex-dividend dateEx-dividend DateAn ex-dividend date is one of the four important dividend dates, usually set one business day before the record date. It is a deadline; shareholders need to buy the stocks before this date to become eligible for the upcoming dividend payout. It is also called the ex-date.read more. In the case of preferred stock, the dividend receiver must have owned the stock for more than 90 days during 181 days, starting from 60 days before the ex-dividend date.
  2. Payer: Payer, i.e., the organization paying the dividend, must be either a United States corporation, or foreign corporation whose country qualifies with the tax treaty with the United States, or a foreign corporation whose stocks are readily traded on the established stock exchanges within the United States.

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Example

Suppose the above Mr. Alex has received Qualified Dividend income instead of an unqualified dividend income of $10,000 in a year and is in a 15% tax bracket based on their entire income sources. In that case, Mr. Alex has to pay 0% tax on that dividend income of $10,000. If Mr. Alex’s income rises next year and comes under a 39.6% tax slab, then he needs to pay $2,000, i.e., 20% as the tax on the same qualified dividend income of $10,000 received next year.

However, a specific dividend fails to become a qualified dividend when received from Real Estate Investment Trust (REIT)Real Estate Investment Trust (REIT)A Real Estate Investment Trust (REIT) is a company that owns and operates real estate properties. Typically REITs are public companies and allow consumers to trade shares in real estate on major stock exchanges.read more, Employees Stock Option Scheme (ESOP), Tax Exempt CorporationTax Exempt CorporationTax-exempt refers to excluding an individual's or corporation's income, property or transaction from the tax liability imposed by the federal, local or state government. These exemptions either allow total relief from the taxes or provide reduced rates or charge tax on some items only.read more, Bank Deposits, etc. Instead, these are directly taxed as ordinary or unqualified dividend income.

What is Ordinary Dividend?

When the dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more is taxed under the standard Income Tax Rate as per the individual tax bracket of the investor, it is treated as an Ordinary or Unqualified Dividend. Normally all the dividends are Ordinary Dividend unless specifically marked as Qualified Dividend. The Income Tax Rate ranges between 0% to 39% tax brackets, and one has to pay taxes on their Unqualified Dividend income according to their respective tax bracket.

Example

Suppose a hypothetical investor, Mr. Alex, has received an Unqualified Dividend income of $10,000 in a year and is in a 15% tax bracket based on their primary income sources. In that case, Mr. Alex has to pay 15% tax on that dividend income of $10,000, i.e., $1,500.

Qualified vs. Ordinary Dividend Infographics

Let’s see the top 5 differences between qualified dividends vs. ordinary dividends.

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Key Differences

  1. The ordinary dividend is taxed per income tax rates, and it is expensive in the hands of investors. A qualified dividend is taxed as per the capital gain tax rate, and it is less expensive for investors.
  2. Tax rates range from 0% to 39.6% on ordinary dividends, so it doesn’t look beneficial to the investors. In contrast, tax rates are lower and range from 0% to 20% on qualified dividends.
  3. The ordinary dividend doesn’t have any eligibility criteria as investors have to pay the same taxes per their respective tax bracket, and no concession is provided on ordinary dividend income. In contrast, the qualified dividend has to meet eligibility criteria, i.e., holding period and payers criteria, to get the benefits of lower tax payments on their qualified dividend income.

Qualified vs. Ordinary Dividends Comparative Table

Basis of ComparisonOrdinary DividendQualified Dividend
MeaningA dividend is taxed as per Income Tax Rate.A dividend is taxed as per Capital Gain Tax Rate.
Tax RatesRanges between 0% to 39.6%Ranges between 0% to 20%
Tax PaymentHigher Tax PaymentLower or No Tax Payment
Eligibility CriteriaNo such criteriaHolding period and Payer criteria must have to be met.
BeneficialLess Beneficial for InvestorsMore Beneficial for Investors

Conclusion

The qualified dividend is very beneficial from the investors’ point of view as they can save more money by paying lower taxes on their dividend income. Usually, all companies in the United States pay qualified dividends on their stocks. But to classify a dividend as a qualified dividendQualified DividendQualified dividends are labeled as ordinary and meet all of the requirements to be taxed at CG (capital gains) rates rather than the higher income tax rates that apply to ordinary and non-qualified dividends. A qualifying international entity or a U.S. company pays these.read more, both stockholder and organization must meet holding period and payers criteria, respectively. The intention is that the Government wants investors to hold stocks for a longer period, not just for tax-saving purposes.

Thus, the tax concession on the dividend income can only be availed by the investors who are investing in the stocks of companies for the longest time and have no intention to trade them for a shorter period. Due to this tax concession facility, many people are attracted to investing their money in stocks instead of investing it somewhere else. This will help to grow the financial marketFinancial MarketThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more in the country.

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