Qualified Vs. Nonqualified Dividends
Receiving dividends from owning stock can seem like a nice bonus when calculating your return on investment. Then when it comes time to pay taxes on the dividends, it can get very confusing. Some dividends are considered to be qualified while others are non-qualified. Qualified dividends enjoy a cheaper tax rate, but you have to understand the rules associated with these dividends to take advantage of it.
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Function
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When a company makes a profit, it can decide to distribute part of its money to the investors. Both qualified and non-qualified dividends are paid by corporations out of profits. This helps keep the shareholders happy, and it makes the company seem like a more attractive investment for outsiders. Dividends are not the same as the capital gains you might make when a stock increases in value. You do not need to sell your stock to receive dividends, and companies may continue to pay dividends even when the stock value has declined. At the end of the year, the company is required to issue stockholders a 1099 reporting both the qualified and non-qualified dividends it paid to the investor over the past tax year.
Tax Rates
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When you receive a dividend, it is important to determine if it is qualified or non-qualified because you pay a different amount of tax on each. For non-qualified dividends, you pay taxes at your regular marginal tax rate. For qualified dividends, you pay taxes at the long-term capital gains tax rate of five or 15 percent, depending on which bracket you are in. If you are in a high tax bracket, this can provide a significant discount.
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Time Frame
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In order for a dividend to be qualified (for capital gains treatment), it has to fall into a certain time frame of ownership. The ex-dividend date is important to know if you want to determine if your dividends are qualified or not. The ex-dividend date is the date on which the company requires you to own the stock if you want a dividend. All stock holders who own the stock on that date will receive a dividend. In order to receive a qualified dividend, you have to own the stock for at least 60 days around the ex-dividend date. There is a 121 day period that starts 60 days before the ex-dividend date and goes to 60 days after the ex-dividend date. If you own the stock for 60 days in that period, your dividends are qualified.
Other Restrictions
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The company that issues the dividend must also meet several requirements in order for the dividend to be qualified. Some requirements that must be met are that the issuing company cannot be a foreign company unless its stock is traded through an American depository receipt on a U.S. stock exchange; the company cannot appear on the SEC list of non-qualified dividends and dividends cannot be paid by a real estate investment trust or from mutual fund capital gains distributions.
Considerations
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Your trading style has a lot to do with how much money you could pay in dividend taxes. If you are a "buy and hold" investor who keeps securities for a long period of time, you will generally be dealing with qualified dividends. If you are a day trader, and you like to rapidly buy and sell securities, you may have to pay a higher rate on your dividend taxes.
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References
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