Ordinary dividend

An ordinary dividend is a dividend payment that does not meet the requirements for qualified dividend treatment and is therefore taxed at ordinary income tax rates, up to 37% federally. Ordinary dividends are less tax-efficient than qualified dividends but are still common, particularly from REITs, partnerships, and foreign stocks.

Why some dividends don’t qualify

Not all dividends receive preferential tax treatment. The tax code is structured to incentivize investment in US corporations that pay corporate tax. Dividends that do not qualify for preferential rates include:

REITs (Real Estate Investment Trusts). REITs are required by law to distribute 90% of taxable income to shareholders. Because REITs do not pay corporate-level tax, their dividends cannot receive the “double-tax relief” of preferential rates. REIT dividends are always ordinary income.

Partnerships and S-corps. K-1 income from partnerships and S-corporations is passed through to partners and shareholders as ordinary income, then often further distributed as dividends.

Foreign stocks. Dividends from foreign stocks not listed on a US exchange are ordinary dividends, even if the foreign company is equivalent to a large US corporation.

Preferred stock and hybrid securities. Some preferred shares and other exotic securities pay dividends that do not qualify.

Brokers holding stock for short periods. If you hold a stock for fewer than 60 days surrounding the ex-dividend date, the dividend loses its qualified character and becomes ordinary.

Tax rate and impact

Ordinary dividends are added to your ordinary income and taxed at your marginal tax rate. An investor in the 32% bracket pays 32% on ordinary dividends—more than double the 15% long-term rate for qualified dividends.

Over time, this difference compounds. $10,000 in annual REIT dividends taxed at 32% costs $3,200 per year in tax; the same amount as qualified dividends taxed at 15% costs only $1,500—a difference of $1,700 per year, or $17,000 per decade.

When ordinary dividends are unavoidable

Investors seeking income often cannot avoid ordinary dividends. REITs, for instance, are held primarily for their high dividend yields, which are taxed as ordinary income. A portfolio heavy in REITs will have a higher tax bill than a portfolio of stocks paying qualified dividends. This is a trade-off: REITs often offer inflation protection and diversification benefits that offset the tax drag.

Interaction with tax brackets

Ordinary dividends stack on top of your other income. If you earn $100,000 in wages, you are in the 24% bracket. If you then receive $20,000 in ordinary dividends, your total income becomes $120,000, and those dividends are taxed at 24% (or higher if they push you into the next bracket).

This means that taking on additional ordinary dividend income can have a cascading effect: it not only gets taxed at your marginal rate, but it can push you higher into the brackets, increasing your rate on other income.

Reporting

Brokers report ordinary dividends in Box 1a of 1099-DIV forms (as opposed to Box 1b for qualified dividends). K-1 income from partnerships and pass-through entities appears on K-1 forms instead.

See also