When it comes to earnings and other cash on hand, some companies like to share the love—and the profit—by sending payments to shareholders in the form of dividends. For some investors, this is an advantage of owning shares in some companies. Not all companies pay dividends, and not all dividends are created equal—some are qualified dividends and some are ordinary dividends, and the tax treatment is different for the two types.
A Review on Dividends
When companies choose to share a portion of their profits with the investors who own shares of the firm, those payments are called dividends, and they work generally the same way from company to company.
Typically, dividends are paid in cash (though some might be paid in stock), on a regular schedule—often quarterly, though there are variations. Investors might receive dividends from companies they’re invested in, or from mutual funds they’re invested in that hold shares of dividend-paying companies.
Many investors consider dividends a bonus or reward for investing in a company, and some investors specifically choose to look for dividend-paying companies. All dividends are considered taxable income, but the kind of tax an investor will pay depends on the kind of dividend they receive.
How Are Dividends Paid?
Typically, dividends are paid in cash, and they’re sent by the company directly to your brokerage, which will deposit the money into your account. Or many companies mail checks directly to investors who own shares in their firms.
Alternatively, you might get dividends as additional shares of stock. Some companies and mutual funds offer the option of a dividend reinvestment plan (DRIP) that will automatically buy additional shares with your dividend payment. This has the advantage of both simplifying the process (since you won’t have to receive the cash and then buy more shares yourself) and potentially being less expensive, since many DRIP programs don’t charge commissions. Additionally, some DRIP programs offer the ability to buy additional shares at a discount.
Less commonly, a company might award a property dividend instead of cash or stock payouts. This could include company products, shares of a subsidiary company or physical assets the company owns.
What Is a Qualified Dividend?
Certain dividends from shares in domestic companies and some foreign companies—and that an investor has held for a minimum period of time—are qualified dividends.
Qualified dividends are taxed at a lower rate than ordinary dividends. They’re taxed at the long-term capital gains rate, which ranges from 0% to 20%. Most people won’t pay more than 15% on qualified dividends. As such, investors typically prefer to receive qualified dividends, but they’re the less common kind of dividend paid out.
Qualified dividends must meet certain requirements:
• The dividend must be paid by a U.S. company or a qualified foreign corporation.
• The dividend must not be of the type that does not qualify.
• If you hold common stock, you must have held the shares for more than 60 days during the 121-day period starting 60 days before the ex-dividend date. (That’s the date by which an investor must have purchased shares of a stock in order to receive an upcoming dividend.)
• If you hold preferred stock, you must have held the shares for more than 90 days during the 181-day period starting 90 days before the ex-dividend date.
• A mutual fund must have held the investment unhedged for more than 60 days during the 121-day period starting 60 days before the ex-dividend date, and investors must have held their shares of the mutual fund for the same period.
How to Figure Out if You Have a Qualified Dividend
For investors about to count the number of days they’ve held a stock, be sure to include the day they sold the stock, but do not include the day they bought it.
Here is an example:
Imagine you bought 1,000 shares of ABC Company common stock on July 2, 2020, and you sold the 1,000 shares on August 11, 2020. ABC Company paid a cash dividend of 25 cents per share with an ex-dividend date of July 15, 2020. Your Form 1099-DIV from the company shows $250 in box 1a (ordinary dividends) and in box 1b (qualified dividends). However, you only held shares of ABC Company for 40 days of the 121-day period that began 60 days before the ex-dividend date, so you have no qualified dividends from ABC Company.
Start investing in dividend
paying assets with SoFi invest.
What Is an Ordinary Dividend?
Once you understand qualified dividends, it’s easy to spot the difference between ordinary dividend vs qualified dividend: Any dividend that isn’t a qualified dividend is considered an ordinary dividend—and that’s most of them.
In general, investors should assume that any dividend they receive is an ordinary dividend unless they’re told otherwise. The payer of the dividend is required to identify the type of dividend when they report them on Form 1099-DIV at tax time. (Qualified dividends are reported in box 1b on IRS Form 1099-DIV, while ordinary dividends are reported in box 1a.)
Certain kinds of dividends are not qualified dividends even if they’re reported in box 1b of your Form 1099-DIV, according to the IRS. The following dividends are on this list:
• Capital gains distributions
• Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations, and similar financial institutions
• Dividends from a corporation that is a tax-exempt organization or farmer’s cooperative during the corporation’s tax year in which the dividends were paid or during the corporation’s previous tax year
• Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation
• Dividends on any share of stock to the extent you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property
• Payments in lieu of dividends, but only if you know or have reason to know the payments are not qualified dividends
• Payments shown on Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not qualified dividends
Ordinary dividends must be reported on IRS Form 1040, line 3b, and they are taxed at ordinary income rates, which range from 10% to 37%.
How Qualified and Ordinary Dividends are Reported at Tax Time
Generally, an investor will receive a Form 1099-DIV—“Dividends and Distributions”—from each institution or company that pays a dividend of $10 or more. This form reports your capital gains distributions, dividend and non-dividend distributions, and any taxes withheld from your payments during that tax year. Even if an investor does not receive a 1099-DIV from a company, they are still required to report any dividends on their tax return.
On Form 1099-DIV, dividends are reported as follows:
• Box 1a: Ordinary dividends, representing the total dividends paid to you during that tax year
• Box 1b: Qualified dividends, and this will be the portion of total dividends that qualify for the lower tax rate
• Box 3: Non-dividend distributions, which are a nontaxable return of capital
If you have had taxes withheld from your dividends, this will be reported in box 4.7.
Understanding qualified versus ordinary dividends can help investors make decisions about what account to hold their dividend-paying investments in: Inside a retirement account, such as an IRA, an investor will owe no taxes on dividend income, but they’ll often pay ordinary income taxes on all withdrawals.
Outside a retirement account, an investor will pay lower rates on qualified dividends, and may be able to use dividends to supplement other income or to reinvest in their portfolio.
Whether qualified or ordinary, dividends may provide a source of consistent and predictable income and may be a helpful addition to an investor’s portfolio, depending on their investing goals.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.