Qualified Dividends vs Ordinary Dividends: What You Should Know

Almost every investor will be aware at some point in their life that they are receiving "qualified dividends." This naturally leads to the question: What is the difference between qualified dividends and ordinary dividends? 

Finally, this distinction is crucial because it affects how you are taxed on dividends. The majority of taxpayers pay a 15% tax rate on qualifying dividends. (It is zero for single taxpayers with incomes less than $47,025 as of 2024 and 20% for single taxpayers with incomes greater than $518,901.) However, "ordinary dividends" (also known as "nonqualified dividends") are taxed at your standard marginal tax rate.  

Qualified dividends were first introduced in 2003 when George W. Bush signed tax cuts into law. Previously, dividends were taxed at the taxpayer's standard marginal rate.

The reduced qualifying rate was intended to address one of the most significant unexpected consequences of the United States tax code. By taxing dividends at a higher rate, the IRS encouraged businesses not to pay them. Instead, it incentivized them to engage in untaxed stock buybacks or just hoard wealth. 

By establishing a reduced qualifying dividend tax rate comparable to the long-term capital gains tax rate, the tax legislation encouraged corporations to reward their long-term shareholders with bigger dividends. It also encouraged investors to hold their equities for a more extended period of time in order to earn dividends.  

A qualified dividend must be paid by a US corporation or a foreign company that trades in the United States or has a tax treaty with the US. That aspect is straightforward to understand. 

The following prerequisite is trickier. 

The tax cut was intended to benefit long-term owners. To qualify, you must hold the shares for more than 60 days within the 121-day period beginning 60 days before the ex-dividend date.

If that sounds confusing, consider this: if you've held the stock for a few months, you're most likely getting the eligible rate. If you haven't, you most likely aren't, at least not yet.

However, understanding if you are receiving qualified dividends might help you plan accordingly. Perhaps you can set up your dividend stock portfolio so that lower-taxed qualifying dividends are paid into your taxable brokerage account, and higher-taxed ordinary dividends are paid into your IRA.