• Tax-free for those in the 10% and 15% brackets to the extent total taxable income remains within those brackets
• Taxed at a 15% rate for those in the 25% or higher tax brackets
Nonqualified dividends are taxed at the same rates as ordinary income (currently a 35% maximum*).
Qualified dividends are paid by common and preferred stock of U.S. corporations where the income is derived from U.S. equity securities. Dividends passed through by mutual funds or other regulated investment companies can be qualified or nonqualified, depending on the underlying securities held by the fund. If a fund receives a qualified dividend, that dividend will maintain its qualified status when passed through to shareholders. Distributions from partnerships and real estate investment trusts typically are not characterized as qualified dividends. Also, qualified dividends do not include distributions from preferred debt.
Dividends paid by certain foreign corporations may also be qualified.
• Shares represented by a publicly traded American Depositary Receipt (ADR)
• Shares that are otherwise readily tradable on an established U.S.-securities market
• Corporations incorporated in a U.S. possession
• Corporations incorporated in a country that has an income-tax treaty with the U.S. that contains an exchange of information program approved by the U.S. Treasury
Keep in mind that the foreign corporate dividend may remain subject to foreign withholding tax. It is critical to obtain proper tax classification of an investment to determine whether the dividend is qualified.
How Does the Qualified Dividend Tax Treatment Work?
For example, Jake has $60,000 in annual taxable income, excluding his dividends. Because he is married and files a joint return, he would be in the 15% federal tax bracket. However, his $9,000 in qualified dividends pushes his total income in excess of $69,000, which puts him in the 25% tax bracket.
As a result, $7,000 of Jake’s qualified dividends would be tax-free, while the remaining $2,000
[$71,000 (his total income) – $69,000] would be taxed at 15%.1