Qualified Dividend – Meaning, Requirement, and Example

What is Qualified Dividend?

Qualified dividends are the dividends on which capital gain tax rates are applicable rather than the ordinary income tax rates. Qualified dividend tax rates are lower than the ordinary income tax rates. International Revenue Service (IRS) handles all the aspects regarding these taxes. IRS is the government agency responsible for collecting taxes and enforcement of tax laws in the United States.

Qualified Dividend

Requirements of Qualified Dividend

IRS has provided the following requirements. It should meet all the criteria to classify a dividend as a qualified dividend:

The dividend payment must be 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 into a U.S. possession.
  • The company is entitled to the benefits of an income tax treaty with the United States. IRS has a list of those treaties that are eligible for these benefits. It can be referred to on the IRS website.
  • The company’s stock is traded on any of the established stock markets in the United States. One can find the list of eligible stock markets on the IRS website.

Not listed under “Dividends that are not Qualified Dividends”

IRS has a list of the types of dividends which are automatically excluded from being part of qualified dividends. One can find the exhaustive list on the IRS website. Here are some examples to give an idea:

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

Minimum Holding Period

Minimum holding period

To classify a dividend as a qualified dividend, holding period criteria must be met. 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 you sold the share is included, but the day you purchased is not included in the calculation.

For example, an investor 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 the 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.

Unqualified Dividend Definition

IRS has decided on 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 an unqualified dividend. Investors will have to pay an ordinary income tax rate (applicable to their tax bracket) on the unqualified dividend received. These tax rates will be higher in comparison to tax rates paid on the qualified dividend.

Qualified and Unqualified Dividend Example

Ordinary Income Tax BracketTax Rate for Unqualified DividendTax Rate for Qualified Dividend

Let’s say you are holding 10,000 shares in a company. It declared a $2 per share dividend so that 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 were 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.

This is an overview of the requirements by the 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.

Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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