Dividends represent a portion of a company’s earnings distributed to its shareholders. Of these, ordinary dividends are the most frequent type and are taxed as ordinary income by the IRS. Understanding ordinary dividends is crucial because they can affect your tax bracket and overall tax liability.
What Are Ordinary Dividends?
Ordinary dividends are dividend payments from corporate earnings that do not meet the criteria for “qualified dividends.” While qualified dividends benefit from preferential tax rates, ordinary dividends are taxed at your ordinary income tax rates, the same rates applicable to wages, salaries, and other earned income.
How Ordinary Dividends Work
When a company makes a profit, it may choose to distribute part of those profits to shareholders as dividends. The dividend payment process involves several key dates:
- Declaration Date: The company announces the dividend.
- Record Date: Shareholders on this date qualify for the dividend.
- Ex-Dividend Date: Usually one or two business days before the record date; buying stock on or after this date means you won’t receive the upcoming dividend.
- Payment Date: The dividend is paid out to eligible shareholders.
Received dividends are reported to the IRS and shareholders through Form 1099-DIV. Ordinary dividends are listed in Box 1a, while qualified dividends are reported in Box 1b.
Tax Treatment and Importance
Ordinary dividends are included in your taxable income and taxed at your marginal income tax rates, which for 2024 range from 10% to 37%. This rate contrasts with qualified dividends, which enjoy capital gains tax rates of 0%, 15%, or 20% depending on income. The distinction can significantly impact your tax bill.
Examples of ordinary dividends include those paid by Real Estate Investment Trusts (REITs), certain foreign corporations, and distributions from mutual funds holding non-qualified shares.
Who Receives Ordinary Dividends?
Individuals investing in dividend-paying stocks, mutual funds, or ETFs in taxable accounts typically receive ordinary dividends. Trusts, estates, and other entities may also receive such dividends. Note that dividends paid inside tax-advantaged retirement accounts like IRAs or 401(k)s are generally not taxed until distribution (Traditional accounts) or potentially tax-free (Roth accounts).
Differentiating Ordinary vs. Qualified Dividends
| Feature | Ordinary Dividends | Qualified Dividends |
|---|---|---|
| Tax Rate | Taxed at marginal income tax rates (10%–37% in 2024) | Taxed at long-term capital gains rates (0%, 15%, 20%) |
| Common Sources | REITs, certain foreign corporations, short-term holdings, some mutual funds | Most U.S. corporations’ dividends with stock held over required periods |
| Form 1099-DIV Box | 1a | 1b |
Strategies to Manage Ordinary Dividends’ Tax Impact
- Use Tax-Advantaged Accounts: Invest dividend-paying securities inside IRAs or 401(k)s to defer or avoid current tax.
- Tax-Loss Harvesting: Offset ordinary dividend income with capital losses.
- Carefully Review Form 1099-DIV: Ensure correct reporting of dividends.
- Understand Your Investments: Choose investments that match your tax planning.
Common Misconceptions
- Not all dividends are taxed the same; ordinary dividends face regular income tax rates.
- Dividends are not “free money” since they reduce the stock price by the dividend amount on the ex-dividend date.
- All dividend income, however small, should be reported to the IRS.
FAQs
Q: Are reinvested dividends taxable? Yes, reinvested dividends are taxable in the year received.
Q: Can ordinary dividends raise your tax bracket? Yes, because they add to your taxable income.
Q: How to tell if dividends are ordinary or qualified? Form 1099-DIV boxes 1a (ordinary) and 1b (qualified) provide this information.
Q: Are all foreign dividends ordinary? Not always; some qualify if the foreign corporation meets IRS criteria.
For more detailed IRS guidance on dividends and distributions, see IRS Publication 550: Investment Income and Expenses here.
Understanding ordinary dividends and their tax implications enables investors to plan effectively and minimize unexpected tax burdens.