Qualified dividends are a specific type of dividend that receive preferential tax treatment in the United States. To understand what qualified dividends are, it's essential first to grasp the concept of ordinary dividends.
Ordinary or non-qualified dividends are a corporation's regular cash or stock payments to its shareholders out of its earnings and profits. These dividends are typically taxable at the individual's ordinary income tax rates.
On the other hand, qualified dividends meet specific criteria outlined by the Internal Revenue Service (IRS), making them eligible for a lower tax rate. The primary advantage of qualified dividends is that they are subject to long-term capital gains tax rates, generally lower than ordinary income tax rates.
To be considered qualified, dividends must satisfy the following requirements:
Holding period: The dividend recipient must have held the underlying stock for a specific duration. For most U.S. stocks, this holding period requirement is met if the recipient holds the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
Qualified status: The dividend must be paid by a U.S. corporation or a qualified foreign corporation. To be classified as a qualified foreign corporation, the company must be incorporated in the U.S., eligible for benefits under a U.S. tax treaty, or have its stock traded on a U.S. national securities exchange.
It's important to note that not all dividends automatically qualify for the preferential tax treatment. Dividends from sources such as real estate investment trusts (REITs), mutual funds, certain exchange-traded funds (ETFs) and dividends on employee stock options are generally not considered qualified dividends.