A dividend is the distribution of some of a company’s earnings to its shareholders, as determined by its board of directors.
When it comes to investing in stock market, dividends can be one of your greatest sources of profits. Occurring every quarter, dividends allow shareholders to reap a portion of a company’s profits and can be an excellent way for individuals to earn a steady income stream from their stocks. However, all dividends are not created equal.
What is a Qualified Dividend?
Understanding qualified dividends are critical to your understanding of the stock market. According to the financial experts at SoFi, qualified dividends are a special type of dividends that are “re taxed at the long-term capital gains rate, which ranges from 0% to 20%. Most people won’t pay more than 15% on qualified dividends.”
These dividends have higher qualifications than ordinary dividends. They must be from a certain type of company and have been held for a long enough time to count as a qualified dividend. The IRS typically regulates these qualifications, and some states may have different taxation levels for these dividends.
What is an Ordinary Dividend?
An ordinary dividend is a dividend that does not fall into a qualified dividend. It is also a type of dividend that comes from a Capital gain distribution or is paid on certain types of accounts, such as from credit unions, mutual savings banks, tax-exempt organizations, or more. They are taxed at the same rate as your income.
Furthermore, these dividends are dividends that have not been held for a long enough time to count as an ordinary dividend.
What is the Difference Between the Two?
At the end of the day, the primary difference is the rate at which these dividends are taxed. Ordinary dividends are taxed at the same rate as your income, meaning you will pay a higher tax rate on an ordinary dividend rather than a qualified dividend.
Qualified dividends have a lower tax rate, as they are taxed at the capital gains tax rate. This rate is almost always lower than your personal tax rate.
In other words, for tax purposes, it is preferable to have a qualified dividend rather than an ordinary one.
When it comes to accounting, each stock you own should provide you with appropriate documentation so you can determine whether or not you receive ordinary or qualified dividends. Tracking these documents is critical to filing an accurate tax return, so you should always make sure you know just what kind of dividend you have. From an accounting perspective, it is always safer to assume you have an ordinary dividend, as this will allow you to plan better.
Understanding the difference between these two dividends is vital for accounting and tax planning. If you have any questions, you should connect directly with a tax professional to ensure that you have an adequate understanding of what kinds of dividends you have and the potential tax implications of those dividends.