Your adjusted gross income has a big impact on your total tax bill. A high adjusted gross income can exclude you from credits and deductions you could claim with a lower income. Both ordinary and qualified dividends are included in your adjusted gross income calculation. However, ordinary and qualified dividends are taxed differently compared with other income.
Adjusted Gross Income Calculation
Adjusted gross income, or AGI, is your total income less exclusions and deductions. AGI is calculated before considering personal exemptions, dependency exemptions, and standard or itemized deductions. All income that is taxed, including ordinary dividends and qualified dividends, are included in AGI. To calculate AGI, first add all income from all sources. Next, subtract income that is not taxed, like gifts, Social Security and municipal bond interest. Last, subtract deductions for AGI. Deductions for AGI are limited and include alimony, attorney fees, pension contributions, tuition and student loan interest.
Significance of Adjusted Gross Income
AGI is significant because the Internal Revenue Service often uses it to determine if the taxpayer can claim extra deductions and credits. For example, a taxpayer must have an AGI under a certain threshold to claim educational credits and deductions for tuition and fees. Your AGI also affects how much you can claim in itemized deductions. You can only deduct medical and dental expenses that exceed 7.5 percent of your AGI, so a higher AGI decreases your deduction.
Ordinary Vs. Qualified Dividends
Your dividends are considered either ordinary dividends or qualified dividends. Qualified dividends come from shares of domestic and certain foreign corporations. To be qualified, you must have held the shares for more than 60 or 90 days, depending on whether the stock is common stock or preferred stock. Dividends from mutual funds can also be qualified, depending on the securities that make up the fund. If dividends are from a source that issues qualified dividends, it will be reported in box 1b of Form 1099-DIV.
Dividend Tax Rates
Although both ordinary and qualified dividends are included in AGI, they are taxed differently. Ordinary dividends are taxed at your regular tax rate -- the same tax rate you pay on wages, interest income and professional fees. However, you often don't have to pay as much tax on qualified dividends. For the 2013 tax year, the maximum tax rate on qualified dividends is 20 percent. In comparison, you could pay up to 39.6 percent on other taxable income.
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