There are other ways to earn money from your stock investments besides waiting for the share price to soar higher than a rocket en route to Saturn. The company you've invested in may declare dividends to be paid to you in a number of ways, including cold, hard cash.
But all is not giggles and colored balloons in the world of dividends. Each has its own taxation method, so it's important to know whether you're earning qualified or ordinary dividends. Fortunately, there are a few simple ways to tell the difference.
While ordinary dividends are subject to regular income tax, qualified dividends are subject to capital gains taxes and must meet certain requirements to be considered "qualified."
What Is a Dividend?
A dividend is simply a portion of a company's earnings that are paid to shareholders. Dividends are not guaranteed and usually need to be "declared" by the board of directors, which typically occurs on a quarterly basis. A dividend may be qualified, meaning it is taxed at the capital gains rate, which is usually lower than the regular income tax rate. Ordinary dividends, on the other hand, are taxed as regular income.
Qualified Dividend Requirements
In most cases, the dividends you receive will be ordinary dividends. For dividends to be considered as qualified, they must meet a number of criteria.
They must be paid by a U.S corporation or a qualified foreign corporation doing business in the United States. You must also have held the stock for a specified time frame. For common stock, the holding period is 60 days of the 121-day period before the date that dividends were declared. For preferred stock, the time frame is 90 days during a 181-day period.
Tax Rate Differences
If you receive ordinary dividends, they'll be taxed at the same rate as your other income, like hourly wages or salary. The amount of taxes you pay on qualified dividends will depend on your tax bracket. If your bracket is 22 percent or higher, your dividend tax rate will likely be 15 percent. Even better, if your tax bracket is below 22 percent, you'll pay no taxes at all on the dividend distribution.
Knowing for Sure
You don't have to be a tax titan or dividend devotee to know whether you're receiving ordinary or qualified dividends. When you receive your year-end tax statements, check Form 1099-DIV. If box 1a is checked on the form, the dividends are ordinary. If 1b is checked, it means you've received qualified dividends. Of course, it never hurts to verify that your dividends are classified properly and are being taxed at the correct rate.