Not all dividends are taxed equally. Qualified dividends receive preferential tax treatment, potentially saving you thousands of dollars each year. In this guide, we will explain what qualified dividends are, how they differ from ordinary dividends, and what you need to do to ensure your dividends qualify for lower tax rates.
What Are Qualified Dividends?
Qualified dividends are dividend payments that meet specific IRS requirements and are taxed at the more favorable long-term capital gains rates instead of ordinary income tax rates. This can mean significant tax savings, especially for investors in higher tax brackets.
The tax difference: Ordinary dividends are taxed at your regular income tax rate, which could be as high as 37%. Qualified dividends are taxed at 0%, 15%, or 20% depending on your income level.
Qualified vs Ordinary Dividend Tax Rates
The tax rate difference between qualified and ordinary dividends can be substantial:
Tax Rate Comparison (2024 Rates)
Qualified Dividend Rates:
- 0% for taxable income up to $47,025 (single) or $94,050 (married filing jointly)
- 15% for income up to $518,900 (single) or $583,750 (married filing jointly)
- 20% for income above those thresholds
Ordinary Dividend Rates:
- Taxed as regular income: 10%, 12%, 22%, 24%, 32%, 35%, or 37%
Requirements for Qualified Dividends
For a dividend to qualify for the lower tax rate, it must meet three requirements:
1. Paid by a US Corporation or Qualified Foreign Corporation
The dividend must come from:
- A US corporation
- A corporation in a US territory
- A foreign corporation whose stock is readily tradable on an established US securities market
- A foreign corporation in a country with a tax treaty with the US
2. Meet the Holding Period Requirement
You must hold the stock for a minimum period around the ex-dividend date. For common stocks, you must hold shares for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date.
3. Not Listed as Ineligible by the IRS
Certain types of payments are specifically excluded from qualified dividend treatment, even if they meet the other requirements.
The Holding Period Explained
The holding period requirement is where many investors get tripped up. Here is how it works:
Holding Period Window
For a stock with an ex-dividend date of July 15:
- The 121-day window begins May 16 (60 days before ex-date)
- The 121-day window ends September 13 (60 days after ex-date)
- You must hold shares for more than 60 days within this window
If you bought shares on May 16 and sold on July 20, you held for 65 days, meeting the requirement. If you sold on July 14, you held for only 59 days and would not qualify.
Counting Days Correctly
The day you buy the stock does not count toward the holding period, but the day you sell does count. Also, the count resets if you reduce your risk through hedging strategies like buying puts or selling calls.
Dividends That Do Not Qualify
Even if paid by a US corporation and held long enough, some dividends never qualify for the lower rate:
- REIT dividends: Most real estate investment trust distributions are taxed as ordinary income
- MLP distributions: Master limited partnership payments have their own tax rules
- Money market fund dividends: These are always ordinary income
- Dividends on shares held in employee stock ownership plans (ESOPs): Special rules apply
- Dividends paid on shares you hedged: Reducing risk voids the qualified status
- Capital gain distributions: These are taxed differently, not as qualified dividends
REIT note: While REIT dividends are generally ordinary income, they may be eligible for the 20% pass-through deduction under Section 199A, which can effectively lower the tax rate.
How to Know If Your Dividends Qualified
Your broker will report qualified and ordinary dividends separately on Form 1099-DIV:
- Box 1a: Total ordinary dividends (includes qualified dividends)
- Box 1b: Qualified dividends (this is the amount eligible for lower rates)
Your broker automatically determines which dividends qualify based on the holding period of your shares. You do not need to calculate this yourself in most cases.
Tax Strategies for Dividend Investors
Understanding qualified dividend rules opens up several tax-saving strategies:
Meet the Holding Period
If you are thinking about selling a dividend stock, check whether selling before the holding period ends would convert a qualified dividend to ordinary. Sometimes waiting a few more days saves significant taxes.
Use Tax-Advantaged Accounts Strategically
Consider holding investments that generate ordinary dividends (like REITs) in IRAs or 401(k)s where dividends are not taxed annually. Hold stocks that pay qualified dividends in taxable accounts where they receive the favorable rate.
Harvest Tax Losses Carefully
If you sell a dividend stock at a loss, be aware of the wash sale rule. Also consider whether the sale affects the qualified status of recent dividends received.
Tax Savings Example
Investor in the 32% ordinary income tax bracket receives $10,000 in dividends:
- If ordinary dividends: $10,000 x 32% = $3,200 in taxes
- If qualified dividends: $10,000 x 15% = $1,500 in taxes
- Annual savings: $1,700
Over a 20-year investing career, this difference compounds to tens of thousands of dollars.
Special Situations
Some scenarios require extra attention regarding qualified dividends:
Foreign Stocks and ADRs
American Depositary Receipts (ADRs) and foreign stocks traded on US exchanges can pay qualified dividends if the company's home country has a tax treaty with the US. However, you may also owe foreign taxes, which can be claimed as a credit.
Mutual Funds and ETFs
Funds pass through the character of their dividends. The fund reports what portion of distributions were qualified. Your holding period in the fund must also meet the requirements.
Preferred Stock
Preferred stock dividends can be qualified, but the holding period is longer: more than 90 days during the 181-day period around the ex-dividend date.
Record Keeping Tips
To ensure you get proper qualified dividend treatment:
- Keep records of purchase and sale dates for all dividend stocks
- Note ex-dividend dates for stocks you hold
- Avoid selling dividend stocks shortly before or after ex-dividend dates
- Review your 1099-DIV forms for accuracy
- Keep records of any hedging activities that might affect qualification
Track Your Dividend Tax Status
Pro Trader Dashboard helps you monitor holding periods and dividend qualifications so you can make informed decisions about when to buy or sell dividend stocks.
Summary
Qualified dividends receive favorable tax treatment, with rates of 0%, 15%, or 20% instead of ordinary income rates up to 37%. To qualify, dividends must come from eligible corporations, and you must hold the shares for more than 60 days around the ex-dividend date. Understanding these rules helps you keep more of your dividend income and make smarter decisions about when to buy and sell. Always consult a tax professional for advice specific to your situation.
Learn more about dividend strategies in our guides on dividend investing basics and understanding dividend yield.