Ask a Fool: Are All Dividends Taxed at Lower Rates Than Ordinary Income?

Q: I just bought my first dividend stocks in a standard (taxable) brokerage account. Is it true that all my dividends will be taxed at a lower rate than the rest of my income?

Most dividends get favorable tax treatment, but not all do.

Specifically, most stock dividends meet the IRS definition of "qualified dividends," which gives them the same preferential tax rates as long-term capital gains. Depending on your taxable income, qualified dividends are taxed at a rate of 0%, 15%, or 20%, and this is lower than the corresponding ordinary income tax rates for all U.S. taxpayers.

To be considered a qualified dividend, the payments must have come from a U.S. corporation or a qualified foreign corporation, which usually means it's a company in a U.S. territory or that readily trades on a U.S. exchange. It also must be an ordinary dividend and not a capital gains distribution or other payment type. In addition, you must have held the stock for more than 60 days during the 121-day period starting 60 days before the stock's ex-dividend date.

Another notable exception to the qualified dividend status applies to pass-through income, such as that paid by real estate investment trusts (REITs). On rare occasions, REIT distributions meet the qualified dividend criteria, but it's not common. Master limited partnerships (MLPs) also typically don't get the favorable treatment. However, these types of dividends get the new pass-through tax deduction that applies to qualified business income.

So if you own stocks (aside from REITs and MLPs) that trade on a major U.S. stock exchange, and you own them for more than 60 days, the dividends you receive will likely be classified as qualified dividends and get favorable tax treatment.

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