Paying Taxes on Ordinary and Qualified Dividends

Total returns combine both investment income collected while holding shares and capital gains realized from selling stock at a profit. The IRS always stands at the ready to collect its pound of flesh – and both scenarios trigger taxable events.

Buy-and-hold investors are especially concerned with paying taxes on dividends. For tax purposes, the IRS classifies a subset of ordinary dividends as qualified. This structure dates back to the Economic Growth and Tax Reconciliation Act of 2001 and Jobs and Growth Tax Relief Reconciliation Act of 2003 – colloquially known as the Bush Tax Cuts.

From here, Onyx Investments does expect for the tax code to shift, in line with the whims of the Political Establishment. Tax and Eat the Rich rhetoric is especially problematic for all stock market investors.

Corporate Finance 101

Dividends are subject to double taxation – and are taxed at both the corporate and shareholder level. First, corporations pay dividends out of after-tax profits. For, 2023, the U.S. corporate income tax rate is 21 percent. Additionally, state corporate levies range from 2.5% for North Carolina to 11.5% for New Jersey.

A corporation will account for taxes and dividend payouts on income and cash flow statements within its annual report.

Shareholders then receive these same dividends as income – to be taxed further. U.S. corporations do get a bit of relief, in that 50-65% of dividend income from other domestic corporations may be written off, before paying 21% tax on all income.

Define Ordinary and Qualified Dividends

The IRS defines all dividends as ordinary, with a special subset of the group qualifying for special tax treatment. Qualified dividends are paid out on individual shares of stock held for more than 60 days out of the 120-day time frame evenly split around the ex-dividend date.

Qualified dividends are taxed similarly to long-term capital gains – at zero, 15%, and 20% rates. Most taxpayers will pay 15% on qualified dividends, with single filers earning between $41,675 and $459,750 ($83,350 and $517,200 for married filing jointly) being taxed at this rate.

Ordinary dividends will be taxed at higher ordinary income rates. For 2023-2024, taxpayers will fall into seven separate brackets and pay taxes at 10%, 12%, 22%, 24%, 32%, 35%, and 37% rates. Be further advised that all mutual fund dividends are treated as ordinary dividends.

The tax code is designed to encourage long-term investing. Ordinary incomes are more so associated with rapid-fire stock trading.

Organize and File Tax Paperwork

Brokerages will submit 1099-DIV Dividends and Distributions forms to both the IRS and your address on record to detail ordinary and qualified dividends received throughout the tax year. Investors may reconcile 1099-DIV and account statements against each other to verify the accuracy of the information.

Taxpayers will complete Schedule B to itemize all ordinary dividends according to payers and amounts. From here, we enter ordinary and qualified dividends directly into the income section of the Form 1040 tax return.

Lastly, we reference the Qualified Dividends and Capital Gains Tax worksheet to calculate your final tax bill.

Financial Strategy

Onyx Investments promotes long-term, buy-and-hold investing, which does translate well into qualified dividends and favorable tax treatment.

Still, Onyx invests money to improve total returns, and not specifically to minimize our tax bill. Intelligent investors know when to fold and sell off a bad investment to take a tax write off. Holding onto shares of stock simply to satisfy qualified dividend requirements may result in significant losses that far exceed any supposed tax savings.