How Dividends Are Taxed, What Makes Them Qualified and How to Keep More of Them

Qualified dividends are taxed at the lower long-term capital gains rates of 0%, 15% or 20%, depending on your income. Non-qualified dividends, also called ordinary dividends, are taxed at your regular income tax rate, which can be much higher, so the same dollar of dividend income can leave you with very different amounts after tax.

Whether a dividend qualifies depends on who paid it and how long you held the shares. Most dividends from US companies and many foreign companies qualify if you meet the holding period, while dividends from real estate investment trusts, money market funds and most bond funds usually do not.

This guide explains the rules, the holding period test, which investments pay which type of dividend, how to read your Form 1099-DIV, how ETFs and funds pass dividends through, and how to keep more of your dividend income. Every tax situation is different, so check your own with a qualified tax professional before you act.

Prefer to watch? FRC’s fact-checked investing playlist on YouTube covers dividend investing, including SCHD and JEPI.

What a Dividend Is

A dividend is a payment a company makes to its shareholders, usually from its profits. Many mature companies pay dividends every quarter, and funds that hold those companies pass the dividends on to their own investors.

For tax purposes, the IRS splits dividends into two groups. Qualified dividends receive the lower rates that apply to long-term capital gains, while non-qualified dividends are taxed as ordinary income, like wages.

The difference only applies in taxable accounts. Dividends paid inside an IRA, 401(k) or other tax-advantaged account are not taxed when they are paid, whatever type they are.

Learn How Investment Income Is Taxed

Understanding how dividends are taxed is part of understanding the true return on any investment. FRC’s ETF Investing for Beginners course explains how funds are structured, priced and taxed, including how they pass income on to investors.

If you are building a career in finance, the taxation of investment income is core exam material. FRC’s Series 65 Exam Preparation course covers dividends, capital gains and tax-efficient investing for clients, and it requires no sponsor, while the SIE Examination Preparation course covers investment returns and taxation as part of the exam you can pass before you are hired.

FRC’s programs and memberships are open to everyone, and every course can be spread across interest-free monthly payments. The same knowledge helps whether you are managing your own portfolio or advising others.

The Tax Rates Compared

Qualified dividends are taxed at 0%, 15% or 20%, the same rates that apply to long-term capital gains. Which rate applies depends on your taxable income and filing status, using thresholds the IRS adjusts each year.

Non-qualified dividends are taxed at your ordinary income tax rate, which ranges from 10% up to 37% for the highest earners. For someone in a high bracket, the gap between the two can be large.

Higher earners may also owe the 3.8% net investment income tax on both types of dividend. It applies when modified adjusted gross income is above $200,000 for single filers or $250,000 for married couples filing jointly, thresholds that are not adjusted for inflation.

The Two Tests a Dividend Must Pass

To be qualified, a dividend must pass two tests. First, it must be paid by a US corporation or a qualified foreign corporation.

A foreign corporation generally counts if it is incorporated in a country with a comprehensive income tax treaty with the United States, or if its shares are readily tradable on an established US stock market, such as through American depositary receipts.

Second, you must meet the holding period. Even a dividend from a qualifying company is taxed as ordinary income if you did not hold the shares long enough.

The Holding Period Test

For common stock, you must hold the shares for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first day a buyer is no longer entitled to the upcoming dividend.

For certain preferred stock dividends that cover periods of more than a year, the requirement is longer: more than 90 days during a 181-day period that begins 90 days before the ex-dividend date.

The rule is designed to stop investors from buying shares just before a dividend, collecting it at the lower rate and selling straight away. Long-term investors usually meet it automatically.

What Usually Counts as Qualified

Most regular dividends from US companies held for the required period are qualified. That includes dividends from large, established companies in sectors such as consumer goods, healthcare, industrials, energy and financials.

Dividends from many foreign companies also qualify, provided the company meets the treaty or US trading test. Some foreign dividends are reduced by foreign withholding tax, which may be partly recoverable through the foreign tax credit.

Dividend-focused stock funds that hold mainly US companies, such as the Schwab U.S. Dividend Equity ETF, typically pay mostly qualified dividends. FRC’s guide to SCHD for passive income explains how that fund works.

What Usually Does Not Qualify

Most dividends from real estate investment trusts, or REITs, are non-qualified, because REITs pass through their rental income without paying corporate tax. However, eligible REIT dividends may qualify for a separate deduction under Section 199A, which reduces the tax owed.

Dividends from money market funds and most bond funds are also non-qualified, because they come from interest income rather than corporate profits. Distributions from business development companies are often largely non-qualified for the same reason.

Dividends on shares you did not hold long enough, payments in lieu of dividends on shares lent out in a margin account, and dividends from tax-exempt organizations also do not qualify.

Covered Call and Income ETFs

Many popular income ETFs pay a mix of dividend types. Covered call funds, which sell options on the stocks they hold, often generate a large share of their income from option premiums, which are generally taxed as ordinary income rather than as qualified dividends.

That means a fund’s headline income can be less attractive after tax than it first appears, especially in a taxable account for a high earner. The fund’s annual tax reporting shows how much of each year’s distributions were qualified.

FRC’s guides to JEPI and covered call ETFs explain how these funds generate their income.

How Funds Pass Dividends Through

When you own an ETF or mutual fund, the fund receives dividends from the companies it holds and passes them on to you. The fund reports which part of its distributions is qualified, based on the companies it held and how long it held them.

You must also meet the holding period for the fund’s own shares. If you buy a fund shortly before its distribution and sell soon after, its qualified dividends may be taxed to you as ordinary income.

Funds can also distribute capital gains, which are taxed separately from dividends. Long-term capital gain distributions are taxed at the lower capital gains rates, whatever your holding period in the fund.

Reading Your Form 1099-DIV

Your broker reports dividends on Form 1099-DIV, usually sent early in the year for the previous tax year. Box 1a shows total ordinary dividends, which includes both qualified and non-qualified amounts.

Box 1b shows the part of Box 1a that is qualified. The difference between the two boxes is taxed as ordinary income, and Box 1b is taxed at the lower rates.

Other boxes report capital gain distributions, foreign tax paid and Section 199A dividends from REITs. Your tax software or preparer uses these figures to apply the right rates.

A Worked Example

Imagine an investor in the 24% tax bracket for ordinary income receives $10,000 of dividends in a taxable account. If all $10,000 is qualified and taxed at 15%, the tax is $1,500.

If the same $10,000 is non-qualified, it is taxed at 24%, and the tax is $2,400. The difference is $900 a year on the same amount of income.

Over a decade of reinvesting, that gap compounds. That is why the type of dividend, not just the size of the payment, shapes what an income investor actually keeps.

Where to Hold Each Type of Investment

The way you split investments between account types, known as asset location, can reduce the tax on your dividends. Investments that pay mainly non-qualified income, such as REITs, bond funds and high-income option funds, are often held in tax-advantaged accounts.

Investments that pay mainly qualified dividends, or that are very tax-efficient, are often held in taxable accounts, where they benefit from the lower rates. Broad stock index funds usually fall into this group.

FRC’s guides to the order to invest your money between a 401(k), IRA and brokerage account and choosing tax-efficient ETFs for a taxable brokerage account explain how to plan where each investment sits.

Dividends Inside Retirement Accounts

Inside a traditional IRA or 401(k), dividends are not taxed when paid. Instead, withdrawals in retirement are taxed as ordinary income, so the qualified dividend rates do not apply.

Inside a Roth IRA or Roth 401(k), dividends are not taxed when paid, and qualified withdrawals in retirement are tax-free. That makes Roth accounts especially valuable for investments that generate a lot of non-qualified income.

For investors with a choice of accounts, the qualified or non-qualified status of a dividend is one of the main factors in deciding where to hold each investment.

Using the 0% Rate

Qualified dividends can be taxed at 0% if your taxable income falls within the lowest capital gains bracket. That threshold is set by the IRS each year and is high enough to include many retirees, students and people in lower-income years.

Because the 0% bracket is based on taxable income after deductions, a married couple with a moderate income can sometimes receive a meaningful amount of qualified dividends without owing any federal tax on them. Non-qualified dividends get no such treatment and are taxed at ordinary rates from the first dollar above the standard deduction.

For people with a low-income year, such as early retirement before Social Security or a career break, the 0% rate can make a taxable account full of qualified dividend payers unusually efficient.

Return of Capital Distributions

Not every payment labeled a dividend is a dividend for tax purposes. Some distributions are classified as a return of capital, meaning the company or fund is paying you back part of your own investment rather than paying from earnings.

A return of capital is not taxed when you receive it. Instead, it reduces your cost basis, which increases the taxable gain when you sell, and once your basis reaches zero, further returns of capital are taxed as capital gains.

Return of capital is common with REITs, master limited partnerships and some closed-end funds. It is reported separately on Form 1099-DIV, in the box for nondividend distributions.

State Taxes on Dividends

The qualified dividend rates apply to federal income tax only. Most states tax all dividends as ordinary income, with no lower rate for qualified dividends.

A few states have no income tax at all, so residents pay only federal tax on their dividends. Others have high rates that apply to every dividend, which raises the overall cost of holding income investments in a taxable account.

When you compare the after-tax income from two investments, include your state rate. The gap between qualified and non-qualified income is usually smaller at the state level than at the federal level.

Dividends for Investors Outside the United States

The qualified and non-qualified distinction applies to US taxpayers. Investors who are not US persons are usually taxed differently on dividends from US companies and funds.

US dividends paid to a nonresident are generally subject to 30% withholding tax at source, which may be reduced under an income tax treaty between the United States and the investor’s country. Brokers typically ask nonresident investors to complete Form W-8BEN to claim any treaty rate.

Because FRC’s readers are worldwide, check how dividends are taxed both in the United States and in your own country before you invest. A local tax professional can explain whether foreign tax withheld can be credited at home.

Reinvested Dividends Are Still Taxed

Many investors reinvest dividends automatically. In a taxable account, reinvested dividends are still taxed in the year they are paid, exactly as if you had taken them in cash.

Each reinvestment also adds to your cost basis, which reduces the taxable gain when you eventually sell. Keeping accurate records avoids paying tax twice on the same money.

FRC’s guide to what cost basis is explains how basis is tracked and why it determines the tax owed on a sale.

Common Mistakes to Avoid

The first mistake is judging an income investment by its headline yield alone. A higher yield made up of non-qualified income can leave you with less after tax than a lower yield of qualified dividends.

The second is trading in and out of dividend stocks or funds around payment dates, which can break the holding period and turn qualified dividends into ordinary income.

The third is holding high-income, non-qualified investments in a taxable account when tax-advantaged space is available. Reviewing where each investment sits once a year can reduce your tax bill without changing what you own.

Show What You Know

Dividend taxation, holding periods and asset location are exactly the kind of planning knowledge clients value and employers expect. FRC’s Professional Membership lets you show that knowledge, not just claim it.

A QR code on your resume takes an employer to your verified Digital Profile, with your credentials, your exam progress and a short Video Resume in your own voice. You give them a fuller picture of who you are, and they spend less time checking claims.

Common Questions

What is the difference between qualified and non-qualified dividends? Qualified dividends are taxed at the lower long-term capital gains rates of 0%, 15% or 20%, while non-qualified dividends are taxed at your ordinary income tax rate.

How long do I need to hold a stock for its dividend to be qualified? More than 60 days during the 121-day period that begins 60 days before the ex-dividend date, for common stock.

Are REIT dividends qualified? Most are not. They are usually taxed as ordinary income, although eligible REIT dividends may qualify for a deduction under Section 199A.

Where can I see whether my dividends were qualified? On Form 1099-DIV from your broker. Box 1a shows total ordinary dividends, and Box 1b shows the part that is qualified.

Do qualified dividend rules apply in an IRA? No. Dividends inside an IRA or 401(k) are not taxed when paid, and traditional account withdrawals are taxed as ordinary income, while qualified Roth withdrawals are tax-free.

Your Next Step

Qualified dividends are taxed at lower capital gains rates, while non-qualified dividends are taxed as ordinary income. The source of the dividend, the holding period and the account it sits in decide which you pay.

Start with your most recent Form 1099-DIV and compare Box 1a with Box 1b. Then check whether your highest-income, non-qualified investments could sit in a tax-advantaged account instead.