Qualified vs Ordinary Dividends

Difference Between Qualified vs Ordinary Dividends

Investors can gain on their investment by asset price appreciation and dividend income. Asset price appreciation is the increase in the price of the asset, which means the investor can sell that asset at a higher price than he brought it. Based on the investor’s style of investment and his comfort, investors choose assets suited for them. What is dividend income and its categories and tax implications on investors’ income, which we will see in detail in this Qualified vs Ordinary Dividends article?

What is an Ordinary Dividend?

Dividend refers to cash, reward, or any other benefit that a company gives to its shareholders from its profit. The dividend can be distributed in various forms, such as stocks, cash dividends, or any other legitimate form. An organization’s dividend is guided by its dividend policy which is decided by its board of directors, and it requires the shareholders’ approval for policy implementation. However, it is not mandatory for a company to pay the dividend to shareholders even policy is in place. A dividend is nothing but a part or full of the profit that the organization shares with its shareholders.

After paying for its creditors, a firm can use small/large part or all of its profits to distribute its shareholders as dividends. Whenever a firm announces a dividend, it also fixes an ex-record date, and all shareholders who hold shares as on that date become eligible to get dividend pay in proportion to shareholding. The company usually pays shareholders within a week into the shareholder’s bank account.

In the United States, some of the big organizations do not pay dividends to shareholders and reinvest their total profit in their own business. Firms with high growth potential and at an early stage of their life generally don’t pay dividends as these firms prefer to re-invest all of their earnings to help the higher growth and expansion plans of the firm. whereas established companies try to offer frequent dividends to reward long-term investors.

What is the Qualified Dividend?

The most important thing to understand about qualified dividends is that they are a subcategory of ordinary dividends that are subject to special tax rules by the United States Government, which can save investors’ money on investors’ tax returns. In other words, all qualified dividends are a type of ordinary dividends, but not all ordinary dividends are qualified dividends.

To be a qualified dividend, the following criteria must be met –

• The dividend should be paid by a corporation operating in the United States or by a qualified foreign company;
• The shares should have been held for at least 60 days during the 121 days period, which starts 60 days prior to the ex-dividend date.

If investment meets the above-mentioned criteria outlined by Internal Revenue Service (IRS), then the dividend earned is termed as a qualified dividend.

The ex-dividend date is the date that new shareholders will not be eligible for receiving the declared dividend – which means investors should own the stock before the ex-dividend date to get the dividend as a qualified dividend. However, qualified dividend treatment doesn’t get applied to certain types of dividend payments, such as those that resemble interest more than a dividend.

And some types of dividends are automatically excluded from being qualified dividends, even if they meet the criteria mentioned. These include (but are not limited to the below-mentioned dividends.)

• Dividends held by a corporation in an Employee Stock Ownership Plan (ESOP)
• Capital gains distributions
• Dividends paid by tax-exempt corporations
• Dividends on bank deposits

Head To Head Comparison Between Qualified vs Ordinary Dividends(Infographics)

Below is the top 3 difference between Qualified vs Ordinary Dividends

Key Differences Between Qualified vs Ordinary Dividends

Both Qualified vs Ordinary Dividends are popular choices in the market;

let us discuss some of the major Difference Between Qualified vs Ordinary Dividends

The difference between qualified vs ordinary dividends is quite substantial when the time comes to pay taxes. As the name itself implies, ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at a lower rate.

The primary motto of this structure is to encourage long-term investment as well as benefit the United States citizen by giving tax benefits.

Please Note: There is an additional 3.8 % Net Investment Income Tax for investors whose modified adjusted gross income exceeds 0.2 million dollars ( 0.25 million dollars for married taxpayers filing jointly).

Qualified vs Ordinary Dividends Comparison Table

Below is the 3 topmost comparison between Qualified vs Ordinary Dividends

Tax advantages of qualified dividends (calculation with example)

Consider an example of an investor in the 33 % tax bracket who owns $ 1,000,000 worth of dividend-paying shares, with a yield of 4 % per year. This investor will receive $ 40,000 in income from his dividends.

If the above-mentioned dividends were considered as ordinary income, this investor would get hit with a $ 13,200 tax, reducing the dividend income to $ 26,800. However, if dividends met the definition of “qualified dividend,” the tax would be reduced to $ 6,000.

For a long-term investor, a qualified dividend means that more of the dividend income stays in his portfolio to re-generate more gains in the future.

Conclusion

• A qualified dividend is a type of ordinary dividend, all qualified dividends are ordinary dividends, but not all ordinary dividends are qualified dividends.
• The qualified dividend category benefits the long-term investor if it qualifies qualified dividend criteria.
• Qualified dividends and ordinary dividends have different tax brackets. Qualified dividend-eligible investors pay less tax compared to ordinary dividends.

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