What is the Difference Between an Ordinary Dividend and a Qualified Dividend

Dividend Cartoon

As is the norm with this time of year I have been receiving receiving tax form 1099s from various companies over the past couple weeks.  I usually just give them a glance before filing them away for my appointment with my CPA.  However, tonight I decided to take a look at the one I received today as it was for an account I don’t touch (safe liquid investments that were given to The Wife by her Grandmother).  The first thing I noticed was that the income produced was divided into qualified and ordinary dividends.  This got me got me to thinking, what is the difference between ordinary and qualified dividends?

Ordinary Dividends vs. Qualified Dividends

InvestorWords defines a dividend as,

A taxable payment declared by a company’s board of directors and given to its shareholders out of the company’s current or retained earnings, usually quarterly. Dividends are usually given as cash (cash dividend), but they can also take the form of stock (stock dividend) or other property.

In Publication 550, the IRS explains that

Ordinary (taxable) dividends are the most common type of distribution from a corporation or a mutual fund. They are paid out of earnings and profits and are ordinary income to you. This means they are not capital gains. You can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation or mutual fund tells you otherwise.

It is only when a dividend meets certain requirements that it is awarded “qualified status” and thus a better tax rate (Either 0% or 15%):

    • The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.
    • The dividends are not of the type listed later under Dividends that are not qualified dividends .
    • You meet the holding period (discussed next).

The Holding Period Necessary to Convert an Ordinary Dividend to a Qualified Dividend

You must own the stock for more than 60 days during the 121 day period which begins 60 days before the date the company acknowledges the payout of a a dividend (the ex-dividend date).  This section can get particularly complicated if you are involved in option strategies.

Dividends that Won’t be Qualified Dividends

There are certain dividends that the IRS makes clear won’t qualify for the lower tax rate regardless of how long you held the stock and whether the company is a United States company (or located in a Country with which we have a treaty).  Those dividends that will never be treated as a qualified dividend are:

    • Capital gain distributions
    • Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations, and similar financial institutions. (Report these amounts as interest income.)
    • Dividends from a corporation that is a tax-exempt organization or farmer’s cooperative during the corporation’s tax year in which the dividends were paid or during the corporation’s previous tax year.
    • Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation.
    • Dividends on any share of stock to the extent you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
    • Payments in lieu of dividends, but only if you know or have reason to know the payments are not qualified dividends.
    • Payments shown on Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not qualified dividends.

When I get my taxes down I will be looking to figure out how much of my dividend payments over the course of last year were ordinary vs. qualified!

4 Responses to What is the Difference Between an Ordinary Dividend and a Qualified Dividend

  1. krantcents says:

    Good explanation! Normally, I just send a copy of my mutual fund 1099′s to my CPA and let him classify them.

  2. jack says:

    Does California account for qualified dividends or treat them only as ordinary dividend for tax purposes?

Leave a reply