Taxes are a reality for dividend growth investorsand, for that matter, any investor. You will pay taxes on the dividends you earn. But fortunately, dividend tax rates may be lower than ordinary income taxes from your regular salary if you receive qualified dividends.
As Ben Franklin famously said,
“In this world nothing is certain but death and taxes.”
The Internal Revenue Service (IRS) considersdividendsto be income and thus they are subject to taxes. Also, this is the case even if you reinvest all your dividends through a dividend reinvestment plan or ‘DRIP’ back into the same company.
But fortunately, taxes on dividends can be lower than taxes on your ordinary income from your regular salary if you are receiving qualified dividends. Obviously, this is a good thing. Hence, you can create a passive dividend income stream in retirement that is taxed at a lower rate than your regular salary. We will go over an example later in the article. But the main point is that taxes dividends are treated somewhat differently than taxes on ordinary income.
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Qualified Dividends Defined
The tax rate for dividends depends on whether the dividends are qualified or non-qualified. Qualified dividends are taxed at the long-term capital gains rate, which is lower than the tax rate on regular income. Non-qualified or ordinary dividends are taxed at the regular income tax rate, which is typically a higher rate.
What are qualified dividends? In order to be considered a qualified dividend the dividend must meet thefollowing criteria:
- Paid by a U.S. company or a company in a U.S. possession
- Paid by a foreign company residing in a country that is eligible for benefits under a U.S. tax treaty
- Paid by a foreign company that can be easily traded on a major U.S. stock market
- The stock must have been held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date
- For preferred stock, the stock must be held for more than 90 days during the 181-day period beginning before the ex-dividend date
The IRS lists other rules that must be met. In addition, the IRS lists certain types of dividends at not qualified regardless if the domicile, trading, and holding period requirements are met.
What are Ordinary or Non-Qualified Dividends?
Ordinary ornon-qualified dividendsare pretty much everything else. These are taxed at the regular income tax rate, which is higher than the capital gains rate. This category can include dividends paid out by real estate investment trusts (REITs), master limited partnerships (MLPs), and other pass-through entities.
Dividends paid on employee stock option plans and by tax-exempt companies are non-qualified. Additionally, interest from savings accounts, money market accounts, CDs, and bonds are taxed at your regular income tax rate. Further, dividends received in Roth or Traditional Individual Retirement Accounts (IRAs) are also non-qualified. Special dividends are also non-qualified.
Exceptions exist but it gets complicated pretty fast, so we won’t go into those details in this article.
What are the Qualified Dividend Tax Rates?
The differences in federal tax rates between non-qualified or ordinary dividends and qualified dividends can be significant, especially at higher income levels. The IRS announced the 2024 Tax Brackets.
Dividend Tax Rate in 2024 for Single Filers
The table below is the federal tax rate brackets for single filers in 2024. It shows the difference between ordinary income and qualified dividends.
| Tax Bracket | Tax Rate on Ordinary Income | Tax Rate on Qualified Dividends |
| < $11,600 | 10% | 0% |
| $11,601 to $47,025 | 12% | 0% |
| $47,026 to $47,150 | 12% | 15% |
| $47,151 to $100,525 | 22% | 15% |
| $100,526 to $191,950 | 24% | 15% |
| $191,951 to $243,725 | 32% | 15% |
| $243,726 to $518,900 | 35% | 15% |
| $518,901 to $609,350 | 35% | 20% |
| >$609,351 | 37% | 20% |
Dividend Tax Rate in 2024 for Joint Filers
The table below is the federal tax rate for joint filers in 2024. It shows the difference between ordinary income and qualified dividends.
| Tax Bracket | Tax Rate on Ordinary Income | Tax Rate on Qualified Dividends |
| < $23,200 | 10% | 0% |
| $23,201 to $94,055 | 12% | 0% |
| $94,056 to $94,300 | 12% | 15% |
| $94,301 to $201,050 | 22% | 15% |
| $201,051 to $383,900 | 24% | 15% |
| $383,901 to $487,450 | 32% | 15% |
| $487,451 to $583,750 | 35% | 15% |
| $583,751 to $731,200 | 35% | 20% |
| >$731,201 | 37% | 20% |
Dividend Tax Rate in 2023 for Single Filers
The table below is the federal tax rate brackets for single filers in 2023. It shows the difference between ordinary income and qualified dividends.
| Tax Bracket | Tax Rate on Ordinary Income | Tax Rate on Qualified Dividends |
| < $11,000 | 10% | 0% |
| $11,001 to $44,625 | 12% | 0% |
| $44,626 to $44,725 | 12% | 15% |
| $44,726 to $95,375 | 22% | 15% |
| $95,376 to $182,100 | 24% | 15% |
| $182,101 to $231,250 | 32% | 15% |
| $231,251 to $492,300 | 35% | 15% |
| $492,301 to $578,125 | 35% | 20% |
| >$578,126 | 37% | 20% |
Dividend Tax Rate in 2023 for Joint Filers
The table below is the federal tax rate for joint filers in 2023. It shows the difference between ordinary income and qualified dividends.
| Tax Bracket | Tax Rate on Ordinary Income | Tax Rate on Qualified Dividends |
| < $22,000 | 10% | 0% |
| $22,001 to $89,250 | 12% | 0% |
| $89,251 to $89,450 | 12% | 15% |
| $89,451 to $190,750 | 22% | 15% |
| $190,751 to $364,200 | 24% | 15% |
| $364,201 to $462,500 | 32% | 15% |
| $462,501 to $553,850 | 35% | 15% |
| $553,851 to $693,750 | 35% | 20% |
| >$693,751 | 37% | 20% |
Are Your Dividends Are Qualified or Not?
It all sounds complicated. You are likely asking yourself; how do I know if my dividends are qualified or not? Luckily, you do not have to make that determination. Instead your brokerage firm must do so. You should receive a1099-DIV at the end of the year listing all your dividends providing your dividends are over $10.
The form should also state whether a dividend is qualified or not. For example, line 1a of your form 1099-DIV should list the total amount of non-qualified or ordinary dividends and line 1b will list the total amount of qualified dividends. In addition, the 1099-DIV will also list your qualified dividends by company and when they were paid.
If you own shares in an MLP your dividends will be reported in a Schedule K-1. A Schedule K-1 is also used if you receive dividends from a trust, estate, partnership, LLC, or S corporation. However, you should also receive a 1099-DIV to list the dividends that you have received.
These forms are required to be sent to you by January 31stby your brokerage firm.
Investing in Dividend Stocks Is Tax Efficient
Investing in dividend stocks is more tax efficient than investing in bonds, money markets, savings accounts or CDs. Of course, there is more risk investing in stocks that pay dividends compared to investing in savings accounts, CDS, or money markets because stocks fluctuate in value and you can lose your initial principle. That said, let’s take a look at an example of the better tax efficiency with stocks that pay dividends compared to a CD.
Let’s assume you have $100,000 invested in a CD that pays 3% and $100,000 investing in dividend paying stocks that yields 3%. What is the impact of taxes on the interest income and dividends of the respective investments? Three percent of $100,000 is $3,000. In the case of the CD, the $3,000 is taxed as ordinary income. If you are earning $50,000 per year then your tax rate is 22%. So, you would have to pay $660 in taxes. This gives $2,340 and an after-tax yield of 2.34%. In the case of qualified dividends, the $3,000 is taxed at the long term capital gains rate of 15%. So, you would pay $450 in taxes. This gives $2,550 and an after-tax yield of 2.55%. The table below summarizes these results.
| CD | Dividend Stocks | |
|---|---|---|
| Investment | $100,000 | $100,000 |
| Income Level | $50,000 | $50,000 |
| Tax Rate | 22% | 15% |
| Interest | $3,000 | – |
| Qualified Dividends | – | $3,000 |
| Taxes | $660 | $450 |
| Net | $2,340 | $2,550 |
| After-Tax Yield | 2.34% | 2.55% |
You can see that qualified dividends are more tax efficient than interest income or even ordinary dividends. The 0.21% difference seems small, but it can add up over time. Imagine that if the extra $210 is reinvested and you leverage the power of compounding.
Dividends in Retirement Accounts
An investor can possibly own dividend paying stocks in their retirement accounts assuming the plan permits it. The main advantage to this is the dividends can be reinvested and compound tax free. However, you will still need to pay taxes on your contributions or your withdrawals depending the type of retirement account. But your money will grow tax-free within the retirement account.
History of Qualified Dividends
Qualified dividends did not always exist. In context of dividend investing they are a relatively new concept and category of dividend.
The Start of Qualified Dividends
In 2003, tax cuts were signed into law. Before this law was implemented, all dividends were taxed at the same rate as regular income. But the Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced all taxpayers’ personal income tax rates and cut the tax rate on qualified dividends from the ordinary income tax rates to the lower long term capital gains tax rates. In addition, the long term maximum capital gains tax was reduced from 20% to 15%. A tax rate of 5% was also established for taxpayers in the two lowest ordinary income tax brackets of 10% and 15%.
At the time, the thinking was that differences in tax rates incentivized companies not to pay dividends. Instead, companies were being encouraged to conduct share repurchases or to hold cash. Recall, that this was shortly after the dot-com bull market, which saw a huge surge in share buybacks and a relatively low percentage of companies were paying dividends. Share buybacks were not taxed. In addition, many companies just simply held cash.
The new category of qualified dividends and tax rates had sunset provisions. However, the Tax Increase Prevention and Reconciliation Act of 2005 prevented the sunset provisions from taking effect. It also lowered the 5% tax rate to 0% on the two lowest ordinary income tax brackets.
Qualified Dividends Become Permanent
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the category of qualified dividends for two more years. Finally, in 2013, The American Taxpayer Relief Act of 2012 made qualified dividends a permanent part of the tax code. It also added a 20% tax rate on dividends in the new highest 39.6% ordinary income tax bracket. As a result, the taxes on your dividends are now always lower than taxes on your regular income or salary.
Creating a lower qualified dividend tax rate that was equal to the long term capital gains tax rate should ideally have benefitted long term shareholders interested in dividends and reducing taxes. Whether this worked or not can probably be debated.
However, many tech companies that did not pay a dividend or only paid a small dividend, now pay a growing dividend with a decent yield. But many other tech companies still do not. For example, Google does not pay a dividend, a policy that will probably not change in the near future because they are investing in growth and face strong competition.
Bottom Line About Dividends and Taxes
The bottom line is dividends matter because they are a great way to generate a passive income stream. The dividends are for the most part predictable and they tend to grow over time in well managed companies. Consequently, this results in a rising dividend income stream.
However, taxes are a reality of investing in dividend paying stocks since the IRS views dividends as taxable income. Fortunately, qualified dividends are tax efficient compared to regular taxable income and ordinary dividends.
Qualified dividends are taxed at the lower long term capital gains tax rate as opposed to the higher regular income tax rate. Hence, the after-tax yield is higher, and you get to keep more of the money compared to some other investments. Moreover, if that money is reinvested over time it can compound, which is an advantage of dividend growth investing.
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Prakash Kolli
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.
