Taxation Of Dividends

In this week’s post, I explain the taxation of dividends.

Dividends are distributions of a portion of a company’s earnings. Dividends are a major reason that investors own shares of stock in a company.

Similar to capital gains, which we discussed last week, dividends can receive special tax treatment in certain circumstances. It is important to point out that this tax treatment of dividends only applies when the shares of stock are held in a taxable investment account. There are many special types of accounts (some of which we have covered in previous posts) that are either tax-free or tax-deferred.

What is a dividend?

When a company has extra cash from the profit of running its business, there are a variety of things it can do with the money: invest it back into its business (for example, building a factory or hiring more employees), buy back its own stock (we will cover this more in a separate post), or distribute some of the profit to its shareholders via dividends, etc.

For example, if a company earns $8/share, the company’s board of directors may decide to distribute half of these earnings ($4/share) to shareholders via a dividend.

To receive the dividend, the investor must purchase the shares before the "ex-dividend date." If an investor purchases shares on or after the ex-dividend date, they will not receive the dividend.

How are dividends taxed?

Unless they are qualified dividends, which we will discuss in a moment, dividends are taxed like ordinary income, such as wages or short-term capital gains. Regular, non-qualified dividends are also called “ordinary” dividends.

What are qualified dividends?

If certain criteria are met, dividends are considered “qualified dividends.” Qualified dividends receive special tax treatment. Here are the criteria:

• The dividend must not be specifically excluded. Specific exclusions include (but are not limited to) “dividends” that are really interest or capital gains distributions.

• The payer must be a US corporation or a foreign corporation that meets certain requirements.

• The investors also must meet the holding period requirement. During the 121 day period beginning 60 days before the ex-dividend date, the investor must hold the shares for more than 60 days. For example, in order to meet the requirement, the investor could buy the shares 60 days before the ex-dividend date then sell the shares a couple of days after the ex-dividend date or the investor could buy the shares a couple of days before the ex-dividend date and then sell them 60 days after the ex-dividend date. It doesn't matter how it's broken up, as long as the shares are held for more than 60 days during the 121 day period.

How are qualified dividends taxed?

Qualified dividends are taxed the same as long-term capital gains (as discussed last week). The special rates depend on filing status and taxable income (these rates are for tax year 2023):

Along with long-term capital gains, the qualified dividends stack on top of regular income after deductions. Just like long-term capital gains, just remember that qualified dividends receive special tax treatment and are typically tax federally at 15% for most moderate income earners.

The net investment income tax can also apply to high income earners. There can also be state taxes on dividends as well.

Examples

Becca and Ken have married filing jointly status. They have combined wages of $80,000 and they use the standard deduction of $27,700. They also received $10,000 of dividends from shares of stock that they purchased on March 8. The ex-dividend date was March 15. They sold the shares on April 9. The dividend is an ordinary dividend, because the holding period requirement is not met. The $10,000 of dividends will be taxed federally at the ordinary income rate of 12%:

Peter is a taxpayer with single filing status. He has $20,000 of wage income and uses the standard deduction of $13,850. He also received $15,000 of dividends from shares of stock he has owned for many years. The dividends are qualified. He does not owe any income tax on the dividends, because total income (including qualified dividends) is well below $44,625, which is the top of the 0% qualified dividend taxable income range for single filing status:

If you have any comments, questions, or ideas for future posts, please let me know

I hope you found this post helpful and educational. If you have any comments, questions, or ideas for future posts, please let me know. You can reach me directly via email at crawford@ulmerfinancial.com.