Corporations pay dividends to their investors. These dividends can be paid as cash, stock, or some other property. Dividends are the investors’ share of corporate profit over a certain time period. The IRS taxes dividends as income. The most common type of payouts to investors is ordinary dividend. The IRS considers these dividends to be ordinary income and taxes them at the taxpayer’s normal tax rate. Dividends are always considered to be ordinary, unless a corporation specifies otherwise.
For a dividend to be considered qualified, it must be issued by a U.S. corporation or a qualified foreign corporation. It cannot fall into the unqualified category, and it must meet the required holding period.
Qualified dividends that would ordinarily fall into a 25% tax rate are taxed at 15% and dividends that would fall under the 25% tax rate are taxed at zero percent.
You must own the stock providing the dividend for more than 60 days of a prescribed 121-day period. The holding period basically persuades long-term investment in order to guarantee that the stock falls into the qualified category where tax savings are realized.
Although calculating the dividends yourself can become complex, the IRS requires the corporation issuing the dividends to report those that are qualified as a special entry in box 1b of your 1099-DIV and ordinary dividends in box 1a.
Ordinary dividends add to your adjusted gross income. The IRS provides a work sheet for you to use to calculate the tax rate of qualified dividends after taking into consideration elements like income and filing status. You deduct qualified dividends from your income and use the worksheet to determine their tax rate. You then calculate the tax owed on your adjusted gross income after the dividends were deducted. You next add the tax rate you determined on your worksheet to the tax you owe on your income, and you have determined your total tax.
Upon completion of your income tax return, you will discover that calculating the special reduced rate of qualified dividends has lowered your tax liability.
The bottom line is that all the calculations save you money. So, it is well worth doing the math.