Qualified Dividend

Qualified Dividend Definition

Qualified dividends are the dividends on which capital gain tax rates are applied rather than the ordinary income tax rates. Qualified dividend tax rates are lower than the ordinary income tax rates. All the aspects related to these taxes are handled by International Revenue Service (IRS). IRS is government agency responsible for the collection of taxes and enforcement of tax laws in the United States.

Unqualified Dividend Definition

IRS has decided some criteria which need to be met to classify an ordinary dividend as a qualified dividend. If a dividend does not fulfill those criteria, it is known as the unqualified dividend. Investors will have to pay ordinary income tax rate (applicable to their tax bracket) on the unqualified dividend received. These tax rates will be higher compared to tax rates paid on the qualified dividend.

Qualified and Unqualified Dividend Example

Ordinary Income Tax Bracket Tax Rate for Unqualified Dividend Tax Rate for Qualified Dividend
10% 10%

0%

15% 15%
25% 25%

15%

28% 28%
33% 33%
35% 35%
39.6% 39.6%

20%

Let’s say you are holding 10,000 shares in a company. It declared $2/ Share dividend so the dividend income would be $ 20,000. To find out the dividend tax rate, you need to know which tax bracket you fall into for the ordinary income. If you fall into the 25% tax bracket, you will have to pay the same rate of 25% on the unqualified dividend income. So the tax expense would be $ 5000 ($ 20,000 * 0.25). If the same dividend was classified as a qualified dividend, you would have paid a lower tax rate of 15%. The dividend expense, in that case, would be $3000 ($20,000 * 0.15). Hence, you will be able to save some amount on the tax if the dividend is a qualified dividend.

Requirements of Qualified Dividend

IRS has provided following requirements. All the requirements must be met to classify a dividend as qualified dividend:

The dividend must have been paid by an American company. If it is a foreign corporation, any of the following conditions need to be met to classify its dividend as qualified:

  • The company has incorporated in a U.S. possession.
  • The company is entitled to the benefits of income tax treaty with the United States. IRS has a list of those treaties who are eligible for these benefits. It can be referred on IRS website.
  • The company’s stock is traded on any of the established stock markets in the United States. The list of the eligible stock market can be found on IRS website.Qualified Dividend

Not listed under “Dividends that are not qualified dividends”

IRS has a list of the type dividends, which are automatically excluded from being part of qualified dividends. The exhaustive list of which can be found on IRS website. Here are some the examples to give an idea:

  • Capital gain distribution by mutual funds or real estate funds
  • Dividend from tax-exempt corporations
  • Dividend paid on the employee securities under employee stock ownership plan (ESOP)

Minimum holding period

Holding period criteria must be met to classify a dividend as a qualified dividend. The requirement is that the stock must be held for more than 60 days during the specified 121-day period. The specified 121-day period begins 60 days before the ex-dividend date.To calculate the number of days, the day on which you sold the share is included but the day on which you purchased it is not included in the calculation.

Minimum holding period

For example, an investor has bought the shares of a company on 11th July, 2016. The investor sold the shares on 16th September, 2016. So you held the stock for 67 days. The company has kept ex-dividend date on 16th July, 2016.  So the 121-day period is from 17th May, 2016 (60 days before the ex-dividend date) to 14th September, 2016. The investor held the stock for 65 days out of 121 days, so he has met the holding period criteria.

This is an overview of the requirements by IRS. You can visit the website of IRS for more information. The website has more information about exceptions to these criteria and a detailed technical explanation of holding period calculation.

References:

Last updated on : August 7th, 2018

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