If you have something called qualified dividend income, it receives special tax treatment.
Qualified dividend income is defined as dividends received during the tax year from a domestic corporation or a qualified foreign corporation. It is taxed at the lower preferential capital gains tax rates.
A domestic corporation is a corporation incorporated within the United States. A qualified foreign corporation is a corporation incorporated in a possession of the United States or a corporation eligible for benefits of a comprehensive income tax treaty with the United States that the secretary of the Internal Revenue Service determines is satisfactory.
In contrast, ordinary dividends are fully includable in gross income. An ordinary dividend is any distribution made by a corporation to its shareholders whether in money or property. The amount of the dividend is the amount of cash received plus the fair market value of any property received, if applicable.
You pay tax on ordinary dividends at your ordinary income tax rates. Your tax bracket determines the rate of income tax that you pay. There are currently seven ordinary income tax rates or brackets.
However, if the corporation’s dividends meet the criteria for qualified dividend income treatment, the lower preferential tax rates apply, as shown in the table below:
Ordinary Income Tax Rate
Qualified Dividend Rate
These rates are applicable for individuals, estates and trusts.
Investments in tax-deferred retirement vehicles such as a regular IRAs, 401(k)s and deferred annuities do not receive any benefit from the preferential rate reduction. Distributions from these accounts are taxed at ordinary income tax rates even if the funds represent dividends paid on the stocks held in these accounts.
There is a 60-day holding period requirement to qualify for the preferential qualified dividends rate. You have to hold a stock at least 60 days within a 121-day period, which begins 60 days before the ex-dividend date and ends 60 days after.
The ex-dividend date is the day after the date of record, which is the date on which all shareholders who own a particular stock will receive a dividend for that period of time.
Obviously, following the rules and qualifying for the preferential qualified dividends rate can result in a substantial tax savings.