The tax treatment of dividends in the U.S. depends on whether the Internal Revenue Code (IRC) classifies them as qualified dividends or ordinary dividends (also referred to as nonqualified dividends.) Qualified dividends are taxed at the same rates as the capital gains tax rate. These rates are lower than ordinary income tax rates.
The tax rates forordinary dividends(typically those that are paid out from most common or preferred stocks) are the same as standard federal income tax rates or 10% to 37% for the 2023 and 2024 tax years. Investors pay taxes on ordinary dividends at the same rates they pay on their regular income, such as salary or wages. Income-tax and capital gains rates change over time, but in recent years, the latter has been substantially lower than the former.
Key Takeaways
- A dividend is part of a company's earnings that is paid directly to shareholders.
- Anyone who receives dividends must pay taxes on them.
- The tax treatment of dividends in the U.S. depends on whether the Internal Revenue Code classifies them as qualified or ordinary dividends.
- Qualified dividends are taxed at the same rates as the capital gains tax rate, which is lower than ordinary income tax rates.
- The tax rates forordinary dividendsare the same as standard federal income tax rates; 10% to 37%.
Qualified Dividends vs. Ordinary Dividends
A dividend is a portion of a company's earnings paid directly to shareholders. Companies that offer dividends pay a fixed amount per share and can adjust it up or down with each earnings period (usually a calendar quarter) based on how the company is doing. The investor must pay taxes on their dividends, but how much they pay depends on whether the dividends are qualified or ordinary.
Qualified dividends, which receive more favorable tax treatment, must meet a few criteria. They must be issued by U.S. corporations publicly traded on major exchanges, such as the Dow Jones or Nasdaq. The investor must own them for at least 60 days out of a 121-day holding period. Certain dividends, such as those derived from an employee stock ownership plan or issued by a tax-exempt organization, are not eligible for qualified status.
There is no significant difference between qualified and ordinary dividends apart from their tax treatment.
Qualified-Dividend Tax Treatment
Investors favor qualified dividends because they are subject to lower tax rates, namely those levied on long-term capital gains rather than those charged on ordinary income. That's true regardless of the investor's tax bracket, though the biggest savings accrue to investors in the top two brackets, where the tax rate difference between the two types of dividends can be as much as 20%.
The tax schedule for qualified dividends features only three levels: 0%, 15%, and 20%.
The tax brackets are as follows:
| Dividend Tax Rates for Tax Year 2023 | ||||
|---|---|---|---|---|
| Tax Rate | Single | Married, Filing Jointly | Married, Filing Separately | Head of Household |
| 0% | $0 - $44,625 | $0 to $89,250 | $0 to $44,625 | $0 to $59,750 |
| 15% | $44,626 - $492,300 | $89,251 to $553,850 | $44,626 to $276,900 | $59,751 to $523,050 |
| 20% | $492,301 or more | $553,851 or more | $276,901 or more | $523,051 or more |
Source: Internal Revenue Service
| Dividend Tax Rates for Tax Year 2024 | ||||
|---|---|---|---|---|
| Tax Rate | Single | Married, Filing Jointly | Married, Filing Separately | Head of Household |
| 0% | $0 - $47,025 | $0 to $94,054 | $0 to $47,025 | $0 to $63,000 |
| 15% | $47,026 - $518,900 | $94,055 to $583,750 | $47,026 to $291,850 | $63,001 to $551,350 |
| 20% | $518,901 or more | $583,751 or more | $291,851 or more | $551,351 or more |
Source: Internal Revenue Service
Individuals who earn $200,000 or more, and married couples who earn $250,000 more, pay an additional 3.8% on investment income, including qualified dividends.
Example of How Dividends Are Taxed
To see the difference these two tax treatments make, imagine an investor with 5,000 shares of Company X that generate $2 each in ordinary dividends, or $10,000 a year. Assume they are single and have a taxable income of $50,000 a year, which places them in the 22% marginal income rate bracket for ordinary income.
Since ordinary dividends receive no special tax treatment, they pay 22%, or $2,200, in taxes on their dividends. However, if their dividend is qualified, they pay a 15% rate, based on their income, or $1,500.
Imagine the same investor, still single, earns a taxable income of $1 million per year, excluding dividends from 50,000 shares of Company X stock. At $2 per share, their yearly dividend is $100,000. Taxed at the 37% top marginal rate, they owe $37,000 in federal taxes on the dividends if they're ordinary, but only $20,000 if they are qualified, a $17,000 savings.
At What Rates Are Dividends Taxed?
If your dividends are qualified dividends they will be taxed at the capital gains tax rate of either 0%, 15%, or 20%, depending on your income tax bracket. If your dividends are ordinary dividends (nonqualified), they will be taxed at your regular marginal income tax rate.
Are Dividends Taxed Twice?
Yes, dividends are taxed twice. This concept is known as double taxation. The first round of taxes occurs on the earnings of a company. Dividends come from a company's earnings and then are distributed to shareholders. Shareholders then have to pay tax on the dividends they receive.
How Do I Minimize the Taxes I Pay on Dividends?
One way to minimize taxes paid on dividends is to try to have qualified dividends, those that incur a lower tax rate than nonqualified dividends. Another method is opening a tax-advantaged brokerage account, such as an IRA, where you can defer taxes paid until you are in a lower income tax bracket when you withdraw from the account.
The Bottom Line
Dividends can be a great way to earn an income stream from your investments, but, like all income, they are also taxed. Depending on the type of dividend, qualified or nonqualified, you will be taxed at either your ordinary income tax bracket or the capital gains tax bracket, which is usually a lower tax rate.
Article Sources
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Internal Revenue Service. "Publication 550, Investment Income and Expenses (Including Capital Gains and Losses," Page 19.
Internal Revenue Service. "Topic No. 404, Dividends."
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2024."
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."
Internal Revenue Service. "Dividends and Distributions," Page 5.
Internal Revenue Service. "Rev. Proc. 2022-38," Pages 8-9.
Internal Revenue Service. "Rev. Proc. 2023-34," Pages 7-8.
Internal Revenue Service. "Questions and Answers on the Net Investment Income Tax."
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As an enthusiast and expert in financial matters, particularly taxation and investment, I bring a wealth of knowledge and practical experience to the discussion of the tax treatment of dividends in the United States. My expertise is grounded in a thorough understanding of the Internal Revenue Code (IRC), tax regulations, and the dynamics of financial markets.
Let's delve into the key concepts addressed in the provided article on the tax treatment of dividends:
Dividends and Their Taxation:
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Definition of Dividends: Dividends are portions of a company's earnings paid directly to shareholders. This represents a share in the profits distributed among the investors.
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Taxation Distinction: The tax treatment of dividends in the U.S. is contingent upon their classification as either qualified dividends or ordinary dividends (nonqualified).
Qualified Dividends vs. Ordinary Dividends:
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Criteria for Qualified Dividends: Qualified dividends receive favorable tax treatment and must meet specific criteria. They must be issued by U.S. corporations publicly traded on major exchanges, and investors must adhere to certain holding period requirements.
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Tax Rates: Qualified dividends are taxed at the same rates as the capital gains tax rate, which is generally lower than ordinary income tax rates.
Tax Rates for Ordinary Dividends:
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Tax Rates for Ordinary Dividends (2023 and 2024): Ordinary dividends, typically paid out from common or preferred stocks, are subject to standard federal income tax rates ranging from 10% to 37%.
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Comparison with Regular Income Tax: Investors pay taxes on ordinary dividends at the same rates as their regular income, such as salary or wages.
Qualified-Dividend Tax Treatment:
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Favorable Tax Rates: Investors prefer qualified dividends due to their subjectivity to lower tax rates, specifically those associated with long-term capital gains. The tax schedule for qualified dividends includes rates of 0%, 15%, and 20%.
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Tax Brackets for Qualified Dividends (2023 and 2024): The tax brackets for qualified dividends vary based on income levels, providing a tiered approach to taxation.
Example of How Dividends Are Taxed:
- Scenario Illustration: The article provides a hypothetical scenario to illustrate the tax implications of ordinary dividends versus qualified dividends for an investor with different income levels.
Additional Concepts:
- Additional Tax for High Earners: Individuals earning $200,000 or more (or married couples earning $250,000 or more) may be subject to an additional 3.8% tax on investment income, including qualified dividends.
Frequently Asked Questions:
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Double Taxation: The article addresses the concept of double taxation, explaining that dividends are taxed twice: first on the company's earnings and then on the dividends received by shareholders.
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Minimizing Taxes on Dividends: Strategies for minimizing taxes on dividends are mentioned, including aiming for qualified dividends with lower tax rates and utilizing tax-advantaged brokerage accounts like IRAs.
Conclusion:
In conclusion, understanding the nuances between qualified and ordinary dividends, along with the associated tax implications, is crucial for investors seeking to optimize their returns while navigating the complex landscape of U.S. taxation on investment income.
The information provided draws on reputable sources, including the Internal Revenue Service (IRS), to ensure accuracy and reliability in presenting the complexities of dividend taxation.
