- Qualified Dividends receive preferential tax treatment as they are taxed as capital gains.
- 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.
What Are Dividends and Why Are They Important?
Dividends are a way for a company to reward current shareholders and attract new investors. When a company has excess profits, it can reinvest the funds into new projects for future growth or disburse the funds to the shareholders in the form of a dividend. Many investors use dividends as a tool for accumulating and distributing wealth.
Dividends are 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 fluctuations in company profits.
Qualified vs. Non-Qualified Dividends: What’s the Difference?
It is important to know the difference between Qualified and Non-Qualified dividends since it will greatly impact the taxes that will be owed. Qualified dividends are attractive because they will receive preferential tax treatment, while non-qualified dividends will not.
In addition, qualified dividends are taxed as capital gains rather than ordinary income so that they may be taxed at a lower rate, such as 20, 15, or even 0 percent, depending on your overall income. A majority of the dividends that are paid out by companies will be Qualified. Still, it is important for tax planning purposes to know the difference and which investment may not yield the extra tax benefits.
How Qualified Dividends Are Taxed
The IRS has set guidelines to determine whether a dividend is qualified. First, the company paying the dividend must be based in the United States or meet other foreign qualifications. This means 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 buy/sell investments frequently, 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 for the company or 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, but 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 dividends, your investment portfolio, taxes, our 401(k)-recommendation service, or anything else in general, please call our office 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 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.
Zachary A. Bachner, CFP®
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