Qualified Dividends vs Ordinary Dividends: How Are Dividends Taxed?

At some point in nearly every investor's life, they will be alerted to the fact that they're collecting "qualified dividends." That inevitably prompts the natural question: What are qualified dividends vs ordinary dividends?

Ultimately, the importance of this distinction has to do with how dividends are taxed. And knowing which is which can be one way to help potentially lower your tax bill.

The tax rate on qualified dividends is 15% for most taxpayers. (It's zero for single taxpayers with incomes under $47,025 as of 2024 and 20% for single taxpayers with incomes over $518,901.)

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However, "ordinary dividends" (or "nonqualified dividends") are taxed at your normal marginal tax rate.

Here are the qualified dividend tax rates for 2024 and 2025:

But on a more fundamental level, investors may want to know what exactly is a qualified dividend, and how can we tell if the income coming from the dividends stocks in our portfolios is qualified?

Investors may also be curious to know which investments pay out non-qualified dividends.

Let's start by examining how qualified dividends were created in the first place. Then we'll look at how that affects the rules governing qualified and ordinary dividends today.

Charles Lewis Sizemore, CFA

Charles Lewis Sizemore, CFA, is the Chief Investment Officer of Sizemore Capital Management LLC, a registered investment advisor based in Dallas, Texas, where he specializes in dividend-focused portfolios and in building alternative allocations with minimal correlation to the stock market. Charles has been a regular contributor to several financial media outlets over the years, including Kiplinger, Forbes and MarketWatch.

What is a qualified dividend?

The concept of qualified dividends began with the 2003 tax cuts signed into law by then-President George W. Bush. Previously, all dividends were taxed at the taxpayer's normal marginal rate.

The lower qualified rate was designed to fix one of the great unintended consequences of the U.S. tax code.

By taxing dividends at a higher rate, the IRS was incentivizing companies not to pay them. Instead, the IRS was encouraging businesses to do stock buybacks (which were untaxed at the time) or simply hoard the cash.

By creating the lower qualified dividend tax rate that was equal to the long-term capital gains tax rate, the tax code instead incentivized companies to reward their long-term shareholders with higher dividends. It also made it more attractive for investors to hold their stocks for longer.

In theory, this would create a better kind of company and a better kind of investor.

It's debatable as to whether the lower rate had the desired effect; in the two decades that have passed, companies (particularly tech stocks) continue to hoard a lot of cash, and buybacks were credited with being one of the biggest drivers of the 2009-2020 bull market.

But it's certainly true that dividends became more of a focus for both investors and the companies paying them following the 2003 tax reforms.

Even tech darlings such as Microsoft (MSFT) and Broadcom (AVGO) regularly pay dividends. And it seems dividends are on the way back, with more and more firms hiking their payouts.

How do I know if my dividends are qualified?

To be a qualified dividend, the payout must be made by a U.S. company or a foreign company that trades in the U.S. or has a tax treaty with the U.S. That requirement is simple enough to understand.

The next part gets tricky.

The 2003 tax cut was designed to reward patient, long-term shareholders. So, to qualify, you must hold the shares for more than 60 days during the 121-day period that starts 60 days before the ex-dividend date.

As a reminder, an investor must own the stock before the ex-dividend date to receive the next dividend payment.

If you're eyes are crossing, just think of it like this: If you've held the stock for a few months, you're likely getting the qualified rate. If you haven't, you're probably not, or at least not yet.

And there are certain types of stocks whose dividends are not considered qualified no matter what.

For example, real estate investment trusts (REITs) and master limited partnerships (MLPs) typically do not pay qualified dividends.

REIT dividends and MLP distributions have more complicated tax rules; however, in some cases, they might actually have lower effective tax rates.

Money market funds and other "bond-like" instruments generally pay ordinary dividends. So do dividends paid out in employee stock-option plans.

The good news: It's actually not your problem to figure this out if you really don't want to. Your broker will specify whether the dividends you received are qualified or not in the 1099-Div they send you at tax season.

But knowing whether you're being paid qualified dividends can help you plan properly. Perhaps you can arrange your dividend-stock portfolio such that your lower-taxed qualified dividends are paid into your taxable brokerage account and your higher-taxed ordinary dividends are paid into your IRA.

If all of this is making your head spin, we can summarize like this:

Most "normal" company stocks you've held for at least two months will have their dividends qualified. Many unorthodox stocks – such as REITs and MLPs – and stocks held for less than two months generally will not.

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