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Public companies raise funds from the external sources by issuing shares. People who buy these shares becomes the shareholders of the company.
Fig 1: Qualified Dividends
In return, the company offers dividend to the shareholders for holding the shares for a time period without selling it in the market. These dividends are grouped into qualified and unqualified dividend. Here, the discussion point will be only about qualified dividend.
Meaning of Qualified Dividends
Qualified dividends are a type of dividend income earned by common stock investors. These dividends are taxed at a lower rate than ordinary dividends. The investor can show these earnings as capital gains instead of income. Qualified dividends are charged under the head of capital gains tax rate. The investors have to meet the necessary criteria as laid down by the IRS to be qualified for this dividend type.
Tax Assessment for Qualified Dividends
As an investor, you must report the income from qualified dividendsin your tax return. The tax for qualified dividends is calculated based on your income tax bracket. Investors are levied with capital gains tax of 0% or 10% or 15% tax depending on their taxable income. The company issues form 1099-DIV to every investor who receives this dividend just to verify and check the type they received. This value must be shown in the tax return form as other income earned in the respective year.
Computation of Qualified Dividends
Knowing how to compute qualified dividends is important as an investor. It can help you save money on your taxes. Here's how you can calculate your qualified dividends −
Firstly, you need to determine if your dividends are qualified. To meet the requirements for receiving dividends, they should have been disbursed by either a U.S. corporation or a foreign corporation that meets the necessary criteria. It is also necessary to hold the stock for a certain duration, which is usually more than 60 days during a period of 121 days that starts 60 days prior to the date for the ex-dividend.
Once you've determined your dividends qualify, you must know your tax bracket. For the tax year 2022, if you're a single filer with taxable income below $40,400 , or a married couple filing jointly with taxable income below $80,800, your qualified dividends are taxed at a 0% rate. If your taxable income exceeds that threshold, your dividends will be taxed at 15% or 20%, depending on your tax bracket.
To calculate the amount of tax you owe on your qualified dividends, you'll need to multiply the total amount of qualified dividends you received by the tax rate that applies to you. For example, if you received $5,000 in qualified dividends and you're in the 20% tax bracket, you'll owe $1,000 in taxes on your dividends.
Fig 2: Company distributing dividends when earned profits
In conclusion, computing your qualified dividends is relatively simple once you understand the criteria for qualification and your tax bracket.
Examples of Qualified Dividends
Now that you know about the assessment and computation of qualified dividends, let's look at two examples of qualified dividends and how they are taxed.
You own 100 shares of XYZ Corporation, and the company pays a dividend of $2 per share. XYZ Corporation is a U.S. corporation, and the dividend is classified as a qualified dividend. Since you held the shares for more than 60 days during the 121-day period that began 60 days before the scheduled date for the ex-dividend, your qualified dividends will be taxed at a maximum rate of 20%, which is lower than the ordinary income tax rate.
Let's say you own shares in ABC Corporation, a U.S. corporation, that paid you a dividend. This dividend qualifies for the lower tax rates that apply to qualified dividends. However, let's say that you held the stock for only 30 days, which is less than the required 60-day holding period.
In this case, the dividend you received would not be considered a qualified dividend, and you would have to pay taxes on it at your regular income tax rate instead of the lower qualified dividend tax rate. It means you would have to pay more in taxes on this particular dividend.
Overall, if you need clarification on the tax treatment of your dividends, it's always a good idea to consult with a tax professional.
Understanding qualified dividends is important for investors as it can impact their tax liability at the end of the financial year.. However, not all dividends are qualified dividends, unless the investor meets the criteria set by the IRS. Learning about this concept can also help them make more informed investment decisions and at the same time, potentially reduce tax burden.
Q1. How can you determine if your dividends are qualified?
Ans. You can tell if your dividends are qualified by checking your 1099-DIV form, indicating whether they are qualified. You can also review the company's financial statements or consult a tax professional.
Q2. Can all dividends be considered Qualified Dividends?
Ans. No, not all dividends can be considered qualified dividends. To qualify, the dividends must meet the specific requirements set by the IRS, such as being paid by a U.S. or qualified foreign corporation and hold for a specific time.
Q3. What are the benefits of receiving Qualified Dividends?
Ans. The lower tax rate is the main benefit of receiving qualified dividends. It can help you keep more investment earnings and reduce tax liability. Additionally, some investors prefer to invest in stocks that pay qualified dividends because they tend to be more stable and reliable.
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