Dividends are a form of income, and Uncle Sam expects to receive his share.
But your dividend tax rate depends on the type of stock you own and which account you hold it in. Qualified dividends get special tax treatment, while ordinary dividends get, well, ordinary income tax treatment.
Here are the basics on dividend tax rates.
What are Dividends?
Dividends are recurring cash payments sent to shareholders of certain well-established companies. They come from the company’s profits, usually earned during the most recent quarter.
Some of the most popular dividend-paying corporations include large banks, pharmaceutical companies, energy and utility companies, and retailers. Real-estate investment trusts (REITs) and master limited partnerships (MLPs) also pay dividends.
Even though some of the most popular public technology companies have a lot of cash on hand, they usually don’t pay dividends because they’re focused on growth and reinvestment.
In the eyes of the IRS, dividends are a form of income. If you receive a dividend from a stock you hold in a traditional brokerage account, rather than a tax-advantaged retirement account, it’s taxable.
How do Dividends Work?
Dividend payments are usually distributed quarterly, but some companies pay on a biannual or annual schedule. Investors receive one dividend per share of stock they own. If a company is paying $1 dividends and an investor owns 100 shares, they’ll receive $100.
A company’s Board of Directors has to approve the dividend payment after evaluating its financials. The company announces the dividend amount, when it will be paid, and when investors had to own the stock to receive the payment (also known as the ex-dividend date). Whether you own the individual stock, or own it through a mutual fund, you’ll receive dividends.
For example, say you bought 100 shares of Exxon Mobil stock on February 20. On May 13, the company announces a dividend payment of 88 cents per share. On June 10, the distribution date, you receive $88. That may not sound like much, but Apple’s dividend payment for the same period was just 23 cents per share.
Dividend payments can fluctuate over time. A group of companies known as the S&P 500 Dividend Aristocrats have each increased their dividends annually for the last 25 years, generating solid long-term returns for shareholders.
Most dividend-paying companies let you choose to receive your money via direct deposit or paper check. Some have automatic reinvestment programs that let you buy additional shares of their stock instead of getting cash.
Qualified Dividends vs. Ordinary Dividends
There are two main types of dividends: qualified and ordinary (also called non-qualified). This is a distinction created and upheld by the IRS for tax purposes. Qualified dividends are taxed at lower rates than ordinary dividends.
A qualified dividend has three characteristics:
- It was paid by a U.S. corporation or qualifying foreign corporation.
- It is not another type of payment that’s being called a dividend — for example, an insurance company kickback, a payment from a tax-exempt organization, or a capital gain.
- It satisfies the holding period.
The holding period requirement for a qualified dividend can get a little confusing. First, you need to know the ex-dividend date of the stock, which is published by the company. Then, count 60 days before that date and 60 days after that date. Together, that should be a 121-day period. If you owned the stock for more than 60 days within that period, you have met the holding requirement. The day you sold your shares counts toward your holding period, but the day you purchased them does not.
Here’s a quick example: Jane owns IBM stock. The ex-dividend date for the stock is May 20. As long as Jane owned the stock for at least 61 days between March 21 and July 19, she would meet the holding requirement.
Any dividend-paying stock that does not have all three characteristics of a qualified dividend is an ordinary dividend.
How are Dividends Taxed?
Dividends you receive from stocks you hold in a traditional brokerage account have to be reported as income when you file your taxes every year. Qualified dividends get special tax treatment and are taxed at the same rates as long-term capital gains, between 0% and 20%. Ordinary dividends are taxed at ordinary income rates, between 10% and 37%.
Dividends you receive from stocks held in retirement accounts, such as an IRA or 401k, aren’t subject to taxes in the year you receive them. That can save you money today, but may be a downside later since you lose the opportunity to pay capital gains rates.
Tax Rates for 2022
These are the rates that applied to qualified dividends received in 2021. They’re the same as the long-term capital gains rates.
|Tax rate||Single||Married filing jointly||Head of household||Married filing separately|
|0%||$0 to $41,675||$0 to $83,350||$0 to $55,800||$0 to $41,675|
|15%||$41,676 to $459,750||$83,351 to $517,200||$55,801 to $488,500||$41,676 to $258,600|
|20%||$459,751 or more||$517,201 or more||$488,501 or more||$258,601 or more|
How to Report Dividend Income
Before the tax deadline each year, every company or brokerage that paid you more than $10 in dividends — whether you accepted it in cash or reinvested it — will send you Form 1099-DIV, Dividends & Distributions. The tax form outlines how much you received in both qualified dividends and ordinary dividends.
You will need to find the sum of your qualified dividends for the year and write it on Line 3a of your federal tax return (Form 1040). If you received more than $1,500 in ordinary dividends, you’ll need to complete Schedule B before reporting the total on Line 3b of your tax return.
If you received dividends from a partnership, you’ll get a Schedule K-1 instead of Form 1099-DIV.
How to Lower a Dividend Tax Bill
The main way to lower your taxes on dividends is to make sure they’re qualified rather than ordinary. This means owning stock from U.S. corporations or certain foreign entities for the appropriate amount of time. For example, someone with a six-figure income would pay a 15% tax on qualified dividends versus a 24% tax on ordinary dividends.
Another way to lower your dividend tax bill is to invest within tax-advantaged accounts. You won’t be able to collect your dividends as income today, but those payments will get reinvested in your account and taxes will be deferred (or in some cases, eliminated).
Here’s how each type of retirement account treats dividends.
- 401k: Withdrawals from 401ks after age 59 ½ (or age 55 if you leave your employer) are taxed as ordinary income, and that includes qualified and ordinary dividends.
- Traditional IRA: If you claimed a tax deduction for contributions to a traditional IRA, any money you withdraw in retirement — including dividends — will be taxed as ordinary income.
- Roth IRA: When you make contributions to this type of account, it’s with money that has already been taxed. As long as your first contribution was made more than five years ago, and you’re at least 59 ½ years old, you won’t owe taxes on any withdrawals you make — even when they include dividends.
The type and location of your dividends determines how much tax you’ll pay and when. Qualified dividends enjoy lower tax rates, but only if you own the stock within a traditional brokerage account. If you own the stock in a retirement account, the dividends will be reinvested and sheltered from taxes in the year you earn them.
That’s good news for compound growth, but once you make a withdrawal in retirement, you’ll pay ordinary income taxes on dividends. These are generally higher than qualified dividend tax rates, unless you wind up in a much lower tax bracket in retirement.
A financial advisor can help you incorporate dividend-paying stocks into your investment portfolio to minimize taxes.
Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer.
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. Compensation not to exceed $500. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.