Federal Taxation of Qualified Dividends

Dividends can be taxed at different rates

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Qualified dividends are a type of investment income that's generated from stocks and mutual funds that contain stocks. They represent a share of corporate profits paid out to investors, and they're considered taxable income by the Internal Revenue Service. This presents some special considerations at tax time regarding filing requirements and various applicable taxes.

What Is a Qualified Dividend? 

Dividends can be taxed at either ordinary income tax rates or at preferred long-term capital gains tax rates. Dividends that qualify for long-term capital gains tax rates are referred to as "qualified dividends."

An investor must hold or own the stock for more than 60 days during a 121-day period that begins 60 days before the ex-dividend date for the dividends to be considered qualified.

Ordinary dividends are more common, and they should be clearly designated as such.

The holding period can be longer for preferred stock. These assets must be held for more than 91 days days during a 181-day period that begins 90 days before the ex-dividend date. This rule applies if the dividends result from time periods of 367 days or more.

Tax Treatment of Qualified Dividends

The tax treatment of qualified dividends has changed somewhat since 2017 when they were taxed at rates of 0%, 15%, or 20%, depending on the taxpayer's ordinary income tax bracket. Then the Tax Cuts and Jobs Act came along and changed things up effective January 2018.

The rates are still set at 0%, 15%, and 20%, but now long-term gains have their own tax brackets. They're no longer tied to ordinary income brackets.

As of the 2020 tax year, you'll fall into the 0% long-term capital gains tax rate for qualified dividends if:

  • Your income is less than $40,000 if you're single
  • Your income is less than $80,000 if you're married and you file a joint return with your spouse
  • Your income is less than $53,600 if you qualify as head of household

The 15% tax bracket kicks in at incomes above the 0% thresholds up to:

  • $441,449 for single filers
  • $469,049 for head of household filers
  • $496,599 for married filers of joint returns in 2020

Only taxpayers with incomes in excess of the 15% thresholds are faced with the 20% capital gains tax rate as of 2020.

Ordinary dividends are taxed as ordinary income according to a taxpayer's tax bracket.

Other Types of Dividends

Ordinary dividends are taxed exactly the same way and at the same rates as your salary, wages, or other earned income.

You might also receive dividends from a trust or an estate, from an S-corporation, or from a partnership. Regardless of whether the corporation or partnership pays you in cash, stock options, or tangible property, the transaction still represents dividends and the value must be reported on your tax return.

You should receive Schedule K-1 for dividends from these sources. All other dividends are reported to investors on Form 1099-DIV.

Reporting Dividend Income: Form 1099-DIV

Form 1099-DIV is issued to investors by mutual fund companies, brokers, and corporations when $10 or more in dividend income is paid out during the year. Form 1099-DIV reports dividends information in the following places:

  • Box 1a: Ordinary dividends reflecting the total amount of dividends paid to you
  • Box 1b: Qualified dividends—the portion of total dividends that qualify for the preferred capital gains tax rate
  • Box 3: Non-dividend distributions, which are a nontaxable return of capital

Some investors opt to have taxes withheld from their dividends. These amounts will appear in box 4.

Reporting on Form 1040

Report dividend income on your 2019 tax return in the following places:

  • Ordinary dividends are reported on Line 3b of your Form 1040.
  • Qualified dividends are reported on Line 3a of your Form 1040.

Be sure to use the Qualified Dividends and Capital Gain Tax Worksheet found in the instructions for Form 1040 to calculate the tax on qualified dividends at the preferred tax rates.

Non-dividend distributions can reduce your cost basis in the stock by the amount of the distribution.

The IRS has issued new Form 1040s for tax years 2018 and 2019. They replace the old 1040, Form 1040-EZ, and Form 1040-A. These lines and entries refer to the 2019 tax form that you'll file in 2020. Forms 1040-EZ and 1040-A are no longer available.

You must still report dividend income on your tax return even if you don't receive a Form 1099-DIV for some reason.

Dividends are taxable regardless and must still be reported if you reinvest them, purchasing additional stock.

Using Schedule B

Schedule B is a supplemental tax form used to list interest and dividend income from multiple sources. Using Schedule B is required if you have over $1,500 in interest income and/or dividends.

Part 1 details taxable interest earned, and Part 2 pertains to ordinary dividends.

It can be helpful to use the form to tally up your interest and dividends for reporting on Form 1040 even if you're not required to file it with your tax return. 

Other Taxes—The Additional Medicare Surcharge 

Dividend income can also prompt the Additional Medicare Tax, which has been in place since the 2013 tax year. This tax is in addition to any income tax you might pay on your dividends.

You must pay an additional 0.9% of your net investment income toward this Medicare tax if you're married filing jointly and your modified adjusted gross income (MAGI) is $250,000 or more, or if you're married filing separately and your MAGI is more than $125,000. The income threshold for all other taxpayers is $200,000.

The Net Investment Income Tax

The Net Investment Income Tax is a heartier 3.8%. It kicks in at the income thresholds of your net investment income or at the same limits as for the Additional Medicare Tax, whichever is less.

All taxable dividends are considered investment income, even if they're taxed at ordinary rates.

Tax laws change periodically. You should always consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and it is not a substitute for tax advice.

Frequently Asked Questions (FAQs)

How are dividends taxed by states?

Most states tax dividends as normal income, so you'll pay the same rate on dividends as you do on the rest of your income. However, New Hampshire taxes all dividends at 6%, regardless of income level.

How often are dividends paid?

Aside from real estate investment trusts (REITs), most businesses have a lot of freedom as to how often they pay out a dividend, when exactly they choose to do so, and how much that payment will be. Many companies that offer dividends do so quarterly, but that isn't a requirement. They can change their plans at any time up until the dividend is announced.

What are Section 199a dividends?

Section 199a deductions were introduced by 2017's Tax Cuts and Jobs Act. It allows individual taxpayers to deduct up to 20% of qualified dividends from domestic REITs and income from public partnerships.