When a taxpayer receives a form 1099-DIV at the end of the year, a common question they have is "what is the difference between an ordinary and qualified dividend?".
A taxpayer that owns or is the beneficiary of an investment that pays dividends will typically receive a form like this at the end of the year. The dividends they received during the year are reported in box 1a "Total ordinary dividends" and any of those dividends that are qualified will be reported in box 1b "Qualified dividends". If dividends are received through a passthrough entity such as a trust or partnership, they will be reported on the Form K-1.
Dividends are the most common way for a corporation to distribute profits to its shareholders. All of the dividends paid to a shareholder during the year are reported as ordinary dividends and are taxable to the taxpayer. Qualified dividends will be included in the amount of ordinary dividends, but are subject to capital gains tax rates.
Qualified dividends are subject to the 15% capital gains tax rate if the taxpayer's regular tax rate is 25% or higher. But, if the taxpayer's regular tax rate is less than 25%, then the qualified dividends are subject to a 0% tax rate. For 2013, the 25% bracket kicks in when adjusted gross income hits $72,500 MFJ / $36,250 S.
In order for dividends to be considered qualified, they must meet three criteria. First, the dividends must have been paid by a US or qualified foreign corporation. Second, the dividends must not be considered capital gain distributions, payments in lieu of dividends, or payments from a tax-exempt organization or a farmer's cooperative. Third, the taxpayer must meet the holding period for the investment.
For a dividend to be considered qualified, the taxpayer must have held the investment for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. So if an investment's ex-dividend date (first day someone can own the investment without receiving the dividend) is September 1, then the taxpayer would have had to own the investment for at least 60 days during the period of July 1 to Nov 1 (121-day period beginning 60 days before ex-dividend date).
Confusing? It can be, but in theory the investment should be owned for a longer term in order for the dividends to qualify for capital gains tax rates.
In all, taxation of qualified dividends with capital gains tax rates is an attractive reason to own domestic, qualified, dividend paying investments for the long-term, as long as the taxpayer is familiar with how the qualified dividends are calculated and whether or not their investments meet the characteristics for qualified dividends.