Federal Taxation of Dividends
Dividends can be taxed at different rates
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 taxed when they're paid out. If your income includes dividends, this presents some special considerations at tax time.
What Is a Qualified Dividend?
Dividends can be taxed either at ordinary income tax rates or at the preferred long-term capital gains tax rates. Dividends that qualify for the lower long-term capital gains tax rates are called qualified dividends.
According to the Internal Revenue Service, an investor "must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date" to be considered a qualified dividend.
But this holding period can be longer in the case of preferred stock, which must be held for 90 days or more during a 181-day period that begins 90 days before the ex-dividend date. This rule applies if the dividends result from time periods exceeding 366 days.
Tax Treatment of Dividends in 2017
Qualified dividends were taxed at rates of 0, 15 or 20 percent through 2017, depending on your tax bracket. Then the Tax Cuts and Jobs Act (TCJA) came along and changed things up somewhat. The rates are still set at 0, 15, and 20 percent, but now long-term capital gains have their own tax brackets—at least through 2025 when the TCJA potentially expires.
If you fell into the 10 or 15 percent ordinary income tax brackets through 2017, your tax rate on dividends was zero. You would include the dividend income with your other income for purposes of determining your tax bracket.
The 15 percent rate applied if you fell into any of the 25 through 35 percent tax brackets, and you would pay 20 percent on qualified dividends if you were in the 39.6 percent bracket. You'd be in this highest bracket if your taxable income was more than $418,400 as of 2017.
Otherwise, if your dividends were not qualified, they'd be taxed exactly the same way as your salary, wages, or other earned income.
Fast Forward to 2018
Beginning with the 2018 tax year and going forward through at least 2025, you'll fall into the 0 percent long term capital gains tax rate for qualified dividends if your income is $38,600 or less if you're single, $77,200 or less if you're married and filing a joint return, or $51,700 or less if you qualify as head of household
The new 15 percent tax bracket kicks in and applies to incomes of up to $425,800 for single filers, $452,400 for head of household filers, and $479,000 for married filers of joint returns. Only those with incomes in excess of these amounts are faced with the 20 percent capital gains tax rate.
These figures are indexed for inflation so they can be expected to increase incrementally each year through at least 2025.
Other Types of Dividends
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 is issued by mutual fund companies, brokers, and corporations to an investor if $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
Dividends are typically ordinary unless a Form 1099-DIV states otherwise.
You'll report dividend income on your tax return in the following places:
- Ordinary dividends are reported on Line 9a of your Form 1040 or Form 1040A.
- Qualified dividends are reported on Line 9b of your Form 1040 or 1040A. Be sure to use the Qualified Dividends and Capital Gain Tax Worksheet found in the instructions for Form 1040 or 1040A to calculate the tax on qualified dividends at the preferred tax rates.
- Non-dividend distributions reduce your cost basis in the stock by the amount of the distribution.
But you can also expect these lines to change as of the 2018 tax year with the return you'll file in 2019. The IRS is issuing a new Form 1040 for 2018 which will replace the old 1040, Form 1040EZ, and Form 1040A. The IRS has promised that the new form comes with detailed instructions, but check with a tax professional if you're confused. They'll be expecting a lot of calls.
You must still report dividend income on your tax return even if you don't receive a Form 1099-DIV for it for some reason. If you reinvest the dividends, purchasing additional stock, they're still taxable and must still be reported.
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. It can be helpful to use the form to tally up your interest and dividends for reporting on your Form 1040 even if you're not required to file it with your tax return.
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 owe on the dividends. If you're single with a modified adjusted gross income of $200,000 or more, or if you're married and your MAGI is more than $250,000, you must pay an additional 3.8 percent of your net investment income toward the Medicare tax.
All taxable dividends are considered investment income, even if they're taxed at ordinary rates.