What Are Ordinary Dividends?
Ordinary dividends are a share of a company's profits passed on to the shareholders periodically. One of the primary advantages of owning stocks, also known as equities, is the regular payment of dividend income.
Dividends are considered "ordinary" by default, although there are cases when a dividend may be classified as "qualified" because it meets specific criteria. Ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at the lower capital gains rate.
Key Takeaways
- Ordinary, or non-qualified, dividends are paid by corporations to shareholders of record.
- Dividends are considered ordinary by default unless they meet special requirements put in place by the IRS.
- Ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at the lower capital gains rate.
Understanding Ordinary Dividends
Dividends earnings fall into two general categories: qualified or nonqualified (ordinary) dividends. Much of the distinction comes from the company paying the earnings and how theInternal Revenue Service (IRS) views the payments.
Unless a dividend payment is classified as a qualified dividend payment, it is taxed as ordinary income. To classify as aqualified dividend instead of an ordinary one, theearnings must come from an American company—or a qualifying foreign company—and it must not be listed as an unqualifieddividendwith theIRS. Also, it must meet a requiredholding period. Holding periods are:
- At least 60 days fora common stock
- 90 days for apreferred stock
- 60 days for a dividend-payingmutual fund
Ordinary dividends may include a range of other dividends or other earnings you may receive throughout the year. These earnings include those paid on real estate investment trusts (REIT). The primary difference between ordinary dividends and qualified dividends is the tax rate.
The tax rate you pay on ordinary dividend earnings is at the same level as taxes for regular federal income or wages. Companies that pay these earnings to stockholders on record report all aggregate ordinary dividends in box 1a of Form 1099-DIV. Mutual fund companies pay and report these dividend payments in the same manner. For tax filings, you will list these earnings on Internal Revenue Service (IRS) Form 1040, Schedule B, Line 5.
Tax Changes on Dividends
The main differences between ordinary dividends and qualified dividends are the rates at which the gains are taxed. Through the years, these tax rates have changed through several acts of Congress.
In 2003, all American taxpayers received a reduction in their income tax rates. The qualified dividend tax rate was also changed from the ordinary income tax rates to lower long-term capital gains tax rates. The legislation that made it possible was called the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). This bill also reduced the maximum long-term capital gains tax rate from 20% to 15% and established a 5% long-term capital gains tax rate for taxpayers in the 10% and 15% ordinary income tax brackets.
A couple of years later, the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) prevented several tax provisions of the 2003 bill from sunsetting, or ending, until 2010. Also, for low to middle-income taxpayers in the 10% and 15% ordinary income tax bracket, it lowered the tax rate again on qualified dividends and long-term capital gains from 5% to 0%.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended these earlier provisions for two additional years.Signed Jan. 2, 2013, the American Taxpayer Relief Act of 2012 made qualified dividends a permanent part of the tax code but added a 20% rate on income in a newly created tax bracket in 2013 (which became the highest tax bracket). All tax brackets may be adjusted for inflation every tax year by the IRS.
In 2021, the maximum tax rate for qualified dividends and ordinary dividends is 20% and 37%, respectively.
The 2017 Tax Cuts and Jobs Act put through by President Trump's administration had little impact on taxes on dividends and capital gains.
Example of Ordinary Dividends
As a hypothetical example, consider the fictitious Joe Investor. He has 100,000 shares of Company ABC stock, which pays a dividend of $0.20 per year. In total, Joe Investor receives 100,000 x $0.20 = $20,000 per year paid in dividends from Company ABC.
Because Company ABC does not pay qualified dividends, Joe Investor must pay the regular income tax rate on those dividends instead of the capital gains tax rate.
FAQs
What are ordinary dividends? Sometimes referred to as “nonqualified dividends,” these are the most common distribution from a corporation or mutual fund. Ordinary dividends are paid out of earnings and profits and are treated as ordinary income. Ordinary income is most earnings other than long term capital gains.
What is an example of an ordinary dividend? ›
As a hypothetical example, consider the fictitious Joe Investor. He has 100,000 shares of Company ABC stock, which pays a dividend of $0.20 per year. In total, Joe Investor receives 100,000 x $0.20 = $20,000 per year paid in dividends from Company ABC.
What is the overview of dividends? ›
A dividend is a portion of a company's earnings that is paid to a shareholder. The most common type of dividend is a cash payout, but some companies will issue stock dividends. Dividends are typically issued quarterly but can also be disbursed monthly or annually.
What is the meaning of ordinary shares dividend? ›
What is the dividend paid on ordinary shares? In simple terms the dividend is a share of the profits the company has made and is generally issued every three or six months. The board of directors meets to decide whether the company has performed well enough to pay a dividend to ordinary shareholders.
What determines if a dividend is ordinary or qualified? ›
Bottom line. Let's recap: the primary difference between ordinary dividends and qualified dividends is how they are taxed. Ordinary dividends are taxed as ordinary income at your regular tax rate, while qualified dividends are taxed at a lower rate, similar to the long-term capital gains tax rate.
How do I report ordinary dividends? ›
Enter the ordinary dividends from box 1a on Form 1099-DIV, Dividends and Distributions on line 3b of Form 1040, U.S. Individual Income Tax Return, Form 1040-SR, U.S. Tax Return for Seniors or Form 1040-NR, U.S. Nonresident Alien Income Tax Return.
How do you calculate ordinary dividends? ›
Here is the formula for calculating dividends: Annual net income minus net change in retained earnings = dividends paid.
How do you explain dividends? ›
A dividend is a reward paid to the shareholders for their investment in a company, and it usually is paid out of the company's net profits. Some companies continue to make dividend payments even when their profits don't justify the expense.
How to make money from dividends? ›
In order to collect dividends on a stock, you simply need to own shares in the company through a brokerage account or a retirement plan such as an IRA. When the dividends are paid, the cash will automatically be deposited into your account.
What is an example of a dividend? ›
For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. The owner of 100 shares would get five additional shares.
Dividend cover, also commonly known as dividend coverage, is the ratio of company's earnings (net income) over the dividend paid to shareholders, calculated as net profit or loss attributable to ordinary shareholders by total ordinary dividend.
What are the disadvantages of ordinary shares? ›
Disadvantages of the Ordinary Shares
(1) Priority distribution of dividends: Priority would be given to Preference shareholders when the dividends are distributed; (2) No guaranteed right to receive dividends: The company can make a decision not to distribute the dividends depending upon the situation.
What is an example of an ordinary share? ›
The number of ordinary shares an investor owns is proportional to the percentage of ownership he/she has in a company. For instance, if a company issues all of its 50 shares in the stock market and you own 30 out of them. You would have a 60% ownership of the company.
Are ordinary dividends considered earned income? ›
Unearned Income. Unearned income includes investment-type income such as taxable interest, ordinary dividends, and capital gain distributions. It also includes unemployment compensation, taxable social security benefits, pensions, annuities, cancellation of debt, and distributions of unearned income from a trust.
Do I pay tax on dividends? ›
Taxable dividend income above the dividend allowance and falling within the higher-rate band is taxed at the dividend upper rate. Taxable dividend income above the dividend allowance and falling above the higher-rate band is taxed at the dividend additional rate.
What is the tax rate on ordinary dividends? ›
The tax rates for ordinary dividends are the same as standard federal income tax rates: 10% to 37%.
What is the difference between a capital dividend and an ordinary dividend? ›
A capital dividend is a type of dividend that is drawn from a company's capital base, as opposed to its retained earnings. Regular dividends are paid from earnings, representing a share of the profits, and are a sign of good financial health as the company has the ability to distribute additional earnings.
What is the difference between ordinary and special dividends? ›
The regular dividend can only be declared and paid after the end of the year, but in the case of a special one, it can be declared and paid at any time during the year.
What is ordinary shares an example of? ›
Ordinary shares also called common shares, are stocks sold on a public exchange. Each share of stock generally gives its owner the right to a single vote at a company shareholders' meeting. Unlike in the case of preferred shares, the owner of ordinary shares is not guaranteed a dividend.
What is a simple example of dividend? ›
What Is an Example of a Dividend? If a company's board of directors decides to issue an annual 5% dividend per share, and the company's shares are worth $100, the dividend is $5.
