A qualified dividend is a dividend that “qualifies” for long-term capital gains tax rates rather than ordinary income tax rates. Come tax time, the difference can greatly impact your obligation to Uncle Sam.
A dividend is a payment that companies make to their shareholders. If you receive a dividend, you usually have to pay taxes on it. But how much depends on whether that payout is qualified or unqualified (ordinary).
A qualified dividend has to meet a few criteria: It must:
Qualified dividends are taxed federally at long-term capital gains tax rates of:
By contrast, unqualified dividends are taxed at your ordinary income tax rate.
In both cases, individuals who make over $200,000 annually ($250,000 for joint filers) also pay an additional 3.8% Net Investment Income Tax (NIIT).
For most investors, sorting qualified versus unqualified dividend-paying investments isn’t an issue, as most U.S. corporations pay qualified dividends. But investors who focus on emerging market investments, REITs, MLPs, or other securities may be in for a nasty surprise come tax time if you’re not prepared.
And speaking of tax time: Brokers make it easy to compare your qualified and unqualified dividends. Every tax year, you’ll receive an IRS Form 1099-DIV that outlines your unqualified dividends (in box 1a) and your qualified dividends (in box 1b).
If you own dividend-paying stocks, the status of your dividends makes a big difference come tax time. As such, your asset allocation is crucial.
To start, if you want to take your dividend income now, it’s generally best to ensure that you:
However, there is a way to defer or even avoid paying taxes on most of your dividends: Hold your securities in a tax-advantaged account. With a traditional or Roth 401(k) or IRA, you can leave your dividends to grow your wealth tax-free (at least for the time being).
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