What are Qualified Dividends?

Qualified dividends are dividends that meets certain criteria and are taxed at lower rates. Those in the 10-15% federal tax brackets don’t have to pay any federal taxes on qualified dividends. Those in the 25% or higher tax brackets only have to pay a 15% tax rate.

The lower tax rates for qualified dividends was first signed into law in 2003 by President Bush and extended twice by President Obama. Currently they are set to expire in the beginning of 2013 unless further extended.

The criteria for qualified dividends requires the company paying out the dividend to be incorporated in the US or is a foreign corporation that trades on a major US exchange as an ADR. There is also a holding period requirement. You must own the stock for at least 60 days out of a 121 day period. This period begins 60 days before the ex-dividend date.

For example, if you bought a stock 60 days or longer before the ex-dividend day and sold a few days after, that dividend paid out would be qualified. Or if you bought a stock 1 day before the ex-dividend date and you held the stock for at least 60 days afterwards, the dividend would also be qualified.

One thing to note though is that dividends from companies with a pass-through tax structure are not qualified dividends. This includes REITs, BDCs, MLPs, and trusts. These companies avoid paying corporate taxes by disturbing 90% or more of their taxable income to shareholders. In turn the dividends / distributions shareholders receive are taxed at normal income levels.

Dividends paid from Mutual Funds, ETFs and CEFs which invest in corporate bonds are also not qualified dividends. They will be taxed at regular income tax rates as well.