It’s no secret that I love dividends.
As a self-employed blogger, putting our investments in dividend-yielding stocks means that we have a relatively stable “floor” of annual income that can help smooth the bumpiness of entrepreneurship. After the last year, it’s been nice to have that “insurance policy” in place.
What’s also nice is that the tax code says that dividends are special. It can be taxed a little bit less than ordinary income.
When I first learned about this treatment, I felt like it was a bit of a cheat code. I understand why the tax code does this – it wants to incentivize reinvestment. The more money that goes back into the stock market, the bigger the market becomes. Everyone (who is able to invest) wins.
So, if you’ve always wondered how dividends were taxed, here’s how I understand it:
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Qualified vs. Ordinary Dividends
Not all dividends are the same. The IRS has decided some some dividends are merely “ordinary” while others are “qualified.” Qualified means they qualify for the lower long-term capital gains tax rates while the ordinary ones are taxed at ordinary tax rates.
Sometimes you’ll see them called “nonqualified” dividends, just to distinguish them from qualified ones, but this term is synonomous with “ordinary” dividends.
There are two parts to determining whether it’s a qualified dividend:
- U.S. company (or a company in U.S. possession, foreign company that’s easily traded on a U.S. stock market)
- holding requirements, explained next.
The holding requirements are that you must own the stock for more than 60 days in a 121- day period that starts 60 days before the ex-dividend date. In other words, you can’t buy the stock “for the dividend” and then sell it immediately afterward.
At tax time, you don’t need to calculate this all yourself. Your brokerage will send you a form (1099-DIV) that outlines your qualified and ordinary dividends. You just need to ensure you don’t make the simple mistake of owning the stock for fewer than 60 days in that 121-day period.
How Are Qualified Dividends Taxed?
For years, the long term capital gains rates were tied to your tax rates. With the Tax Cuts and Jobs Act, they were decoupled and given their own schedule.
The tax rates are still 0%, 15%, and 20% but they are based on this schedule based on income:
| Filing Status | 0% | 15% | 20% |
|---|---|---|---|
| Single | < $40,000 | $40,001 – $441,449 | $441,449+ |
| Married Filing Jointly | < $80,000 | $80,001 – $469,049 | $469,049+ |
| Head of Household | < $53,600 | $53,601 – $496,599 | $496,599+ |
This is only the base rate for your qualified dividends. There are two additional taxes that can be assessed on investment income, both of which are based on your modified adjusted gross income.
There is the Additional Medicare Tax of 0.9% if your modified adjusted gross income is above certain thresholds:
- Single filers and head of household – $200,000
- Married filing jointly – $250,000
- Married filing separately – $125,000
Think we were done? Oh no… we also have the Net Investment Income Tax of 3.8% which uses the same tiers as the Additional Medicare Tax.
- Single filers and head of household – $200,000
- Married filing jointly – $250,000
- Married filing separately – $125,000
There is a silver lining though, you don’t pay both the Additional Medicare Tax and Net Investment Income Tax on the same income. You may be subject to both but you don’t for both on the same type of income. (source, hat tip to my buddyLeif at Physician on Fire for pointing out this clarification)
Both of these taxes were created by the Affordable Care Act.
How Are Ordinery Dividends Taxed?
They’re taxed just like ordinary income, which is based on your income tax bracket.
Easy right? 🙂
How Are Dividends Reported?
Earlier, I said that your broker will take care of calculating the dividends (what is qualified, what is ordinary) – they do that by issuing you a Form 1099-DIV.
You report the dividends on your Form 1040 when you file your taxes. Qualified dividends go on Line 3a and Ordinary dividends go on Line 3b (for Tax Year 2019, so they may change for 2020 but will be in that general area). Super simple.
Brokers have until January 31st to issue a 1099-DIV and you are required to report dividends even if you don’t receive one.
When do I use Schedule B?
Schedule B is a form that you must file if your interest and ordinary dividend income total more than $1,500. It’s a really simple form where you list your sources of interest and ordinary dividends.
It’s not for qualified dividends.
Summary
There are two types of dividends – ordinary and qualified. Ordinary dividends are taxed like income.
Qualified dividends are taxed as long term capital gains. The rate you pay for long term capital gains depends on your income but will be between 0 and 20%. It can help to use a dividend tracker to know when to expect dividend payments.
You don’t need to figure out for yourself which of your dividends are ordinary or qualified – your brokerage will send you the necessary information and forms.
As is the case with taxes, make sure you consult a professional and ensure you have the information for the latest tax year!
