Understanding Dividends: Qualified vs. Non-Qualified and Their Tax Implications

• Qualified Dividends receive preferential tax treatment as they are taxed as capital gains, provided they meet certain requirements.
• Non-Qualified Dividends do not receive any additional tax benefit and are taxed as ordinary income.
• The majority of dividends that are paid out by companies will be considered Qualified, but it is important to note the difference for tax planning purposes.

How Dividends Work and Why They Matter

Dividends are a way for a company to reward current shareholders and attract new investors. When a company has excess profits, they can reinvest the funds into new projects for future growth or they can disburse the funds to the shareholders in the form of a dividend.

Many investors use dividends as a tool of accumulating and distributing wealth. Dividends can be great for retirees since consistent payments can be used as a source of income.

However, dividend payout rates can fluctuate and can sometimes be rather small, so it normally requires a hefty investment account to live solely off dividends. Dividends are not guaranteed and can change in amount due to fluctuation in company profits

Why Knowing the Difference Matters for Taxes?

It is important to know the difference between Qualified and Non-Qualified dividends since it will have an impact on the taxes that will be owed. We feel qualified dividends are attractive because they will receive a preferential tax treatment when certain criteria have been met, while non-qualified dividends will not.

Qualified dividends are taxed as capital gains rather than ordinary income, so they may be taxed a lower rate such as 20, 15, or even 0 percent depending on your overall income.

Most dividends that are paid out by companies will be Qualified, but it is important for tax planning purposes to know the difference and which investment may not yield the extra tax benefits.

IRS Guidelines for Qualified Dividends

The IRS has set guidelines to determine whether or not a dividend is considered qualified. The company paying the dividend must be based in the United States, or it must meet other foreign qualifications.

This means that you are more likely to find non-qualified dividends among international investments. There is a required holding period for the dividend to be qualified, such as 60 or 90 days, depending on the investment type.

If you just bought the investment or if you buy/sell investments frequently then the dividends received may not be qualified if they were not held long enough.

Lastly, the dividend must not be a capital gain distribution from the underlying investment nor come from a tax-exempt company. These situations would already yield preferential tax treatments either for the company or for the investor, so the dividends would not duplicate those benefits again.

Monitoring Your Dividends

When planning for taxes and retirement income, it is important to know whether the dividends you will receive will be qualified or not. Dividends are not guaranteed so the amount may change, and the classification may change as well.

It is best not to assume that every dividend you receive will be qualified since this could jeopardize how much taxes will be owed in the Spring. Your broker or custodian should deliver a 1099 for every year that dividends are received, and it should state which are qualified and which are not qualified.

Your financial advisor and tax planner can use this information to project future year amounts. However, monitoring throughout the year is important to ensure you stay on track to meet your goals.

Speak With a Trusted Advisor

If you have any questions about your investment portfolio, retirement planning, tax strategies, our 401(k) recommendation service, or other general questions, please give our office a call at (586) 226-2100.

Please feel free to forward this commentary to a friend, family member, or co-worker. If you have had any changes to your income, job, family, health insurance, risk tolerance, or your overall financial situation, please give us a call so we can discuss it.

We hope you learned something today. If you have any feedback or suggestions, we would love to hear them.

Best Regards,

Zachary A. Bachner, CFP®

with contributions from Robert Wink, Kenneth Wink, and James Wink.

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