The distinction between Qualified and non-Qualified dividends has to do with how you’re taxed on those dividends.
- Qualified dividends are taxed at 15% for most taxpayers. (It’s zero for single taxpayers with incomes under $40,000 and 20% for single taxpayers with incomes over $441,451.)
- Ordinary dividends (or “nonqualified dividends”) are taxed at your normal marginal tax rate.
The concept of qualified dividends began with the 2003 tax cuts. Previously, all dividends were taxed at the taxpayer’s normal marginal rate.
The lower qualified rate was designed to fix one of the great unintended consequences of the U.S. tax code. By taxing dividends at a higher rate, the IRS was incentivizing companies not to pay them. Instead, it incentivized them to do stock buybacks (which were untaxed) or simply hoard the cash.
By creating the lower qualified dividend tax rate that was equal to the long-term capital gains tax rate, the tax code instead incentivized companies to reward their long-term shareholders with higher dividends. It also incentivized investors to hold their stocks for longer to collect them.
Qualified Dividends
To be qualified, a dividend must be paid by a U.S. company or a foreign company that trades in the U.S. or has a tax treaty with the U.S. That part is simple enough to understand.
Importance of dividends
From 1871 through 2003, 97% of the total after-inflation accumulation from stocks came from reinvesting dividends. Only 3% came from capital gains.”
To put this into perspective, take a look at the example used by John Bogle, where he writes: “An investment of $10,000 in the S&P 500 Index at its 1926 inception with all dividends reinvested would by the end of September 2007 have grown to approximately $33,100,000 (10.4% compounded). If dividends had not been reinvested, the value of that investment would have been just over $1,200,000 (6.1% compounded)—an amazing gap of $32 million.” The reinvestment of dividends accounted for almost all of the stocks’ long-term total return.
Dividends are an important consideration when investing in the share market as they provide a reliable source of return while you wait.
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