When investors receive dividend payments from stocks or funds, the tax treatment of those dividends can vary significantly. A non-qualified dividend is a dividend that does not qualify for the IRS’s lower long-term capital gains tax rates and is instead taxed at the individual’s ordinary income tax rate. This difference can have a notable impact on your tax bill, making it crucial for investors to understand how non-qualified dividends work.
What Defines a Non-Qualified Dividend?
Non-qualified dividends are distributions paid by corporations that fail to meet specific IRS criteria necessary for qualified dividend status. Most importantly, these dividends do not meet the minimum holding period requirements or come from entities whose dividends the IRS automatically classifies as non-qualified. Unlike qualified dividends, which are taxed at 0%, 15%, or 20% depending on your income tax bracket, non-qualified dividends are taxed as ordinary income, which can range from 10% to 37% in 2025, depending on your tax bracket.
IRS Holding Period Rule
To qualify for the favorable tax rates, the IRS requires an investor to hold the stock for more than 60 days during the 121-day period that begins 60 days before the stock’s ex-dividend date. If you do not meet this holding period, any dividends received are classified as non-qualified.
Common Sources of Non-Qualified Dividends
Several types of dividends are commonly classified as non-qualified:
- Dividends from Real Estate Investment Trusts (REITs): Usually non-qualified because of the nature of the income they generate.
- Master Limited Partnerships (MLPs): Often pay distributions treated as return of capital, not qualified dividends.
- Employee Stock Ownership Plans (ESOPs): Dividends are generally non-qualified.
- Foreign Corporations: Dividends may be non-qualified if the company’s stock is not readily tradable on a U.S. exchange or lacks a qualifying tax treaty.
- Dividends from certain foreign stocks or depositary receipts (ADRs, GDRs): Often non-qualified depending on specific factors.
Tax Implications of Non-Qualified Dividends
Unlike qualified dividends, non-qualified dividends are added to your taxable income and taxed according to your ordinary income tax rate. For example, if you are in the 22% tax bracket, your non-qualified dividends are taxed at 22%, whereas qualified dividends might be taxed at a lower 15%. This difference means non-qualified dividends can significantly increase your tax liability.
Who Is Impacted by Non-Qualified Dividends?
Non-qualified dividends affect various investors, including:
- Individual investors holding stocks or mutual funds in taxable accounts
- Retirees relying on dividend income
- Active traders not meeting holding period requirements
- Investors in REITs, MLPs, and other income-focused entities
Strategies to Manage Non-Qualified Dividend Impact
- Understand your investments: Know whether the dividends are typically qualified or non-qualified before investing.
- Hold for the requisite period: Avoid selling stocks before meeting the holding period requirement for qualification.
- Use tax-advantaged accounts: Holding REITs and similar investments in IRAs or 401(k)s can defer taxes.
- Review Form 1099-DIV carefully: This IRS form reports your dividends and distinguishes between qualified and non-qualified amounts.
Key Differences Between Non-Qualified and Qualified Dividends
| Feature | Non-Qualified Dividends | Qualified Dividends |
|---|---|---|
| Tax Rate | Ordinary income tax rate (up to 37%) | Long-term capital gains rate (0%, 15%, 20%) |
| Holding Period | Not met (less than 60 days in 121-day window) | Met (60+ days in 121-day window) |
| Common Sources | REITs, MLPs, ESOPs, certain foreign corporations | Most U.S. corporations and qualifying foreign corporations |
| Tax Impact | Higher tax burden | Lower tax burden |
| IRS Form 1099-DIV Box | Box 1a (ordinary dividends) | Box 1b (qualified dividends) |
Common Misconceptions
- All dividends are taxed at the same lower rate: False. Only qualified dividends get preferential rates.
- Foreign dividends are always non-qualified: Some foreign dividends can be qualified if they meet IRS rules.
- Holding stock long-term automatically makes dividends qualified: Must also meet holding period around ex-dividend date.
Frequently Asked Questions
Q: How can I tell if my dividends are qualified?
A: Check your Form 1099-DIV sent by your broker. Box 1a shows total dividends; Box 1b shows qualified dividends. The difference is non-qualified dividends.
Q: Can a non-qualified dividend become qualified later?
A: No, qualification depends on specific conditions at the time of the dividend payment.
Q: How are dividends from mutual funds treated?
A: Funds can distribute both qualified and non-qualified dividends depending on holdings.
For more detailed guidance, consult IRS Publication 550, “Investment Income and Expenses” https://www.irs.gov/publications/p550.