Much of the material discussed in this chapter will serve as a review of previous chapters. However, some new topics are covered, so we recommend you read the entire chapter.
When you invest, taxes affect what you keep after returns. This chapter focuses on the tax treatment of two common types of investment income:
Dividends
Interest
Dividends
A cash dividend is income received from common or preferred stock. You can also receive dividends from funds (e.g., mutual funds) that pass through income earned by the investments in their portfolios.
Dividends are often taxed at lower rates than other investment income (such as bond interest, discussed later). The rate you pay depends on your annual income tax bracket, which includes all of the following:
Salary
Wages
Commissions
Bonuses
Royalties
As income rises, the tax rate generally rises. That structure is called a progressive tax (discussed further below).
Dividends are either qualified or non-qualified, and that classification determines the tax rate. Qualified dividends are taxed at lower rates than non-qualified dividends.
Qualified dividend tax rates
0% (low income)
15% (moderate income)
20% (high income)
Test questions about tax brackets are usually generalized because brackets change over time. For context, here are the qualified dividend brackets for investors filing single and married filing jointly (tax year 2025):
Tax Rate
Individuals
Married filing jointly
0%
$0 - $48,350
$0 - $96,700
15%
$48,350 - $533,400
$96,700 - $600,050
20%
$533,400+
$600,050+
Do not memorize the specifics; this chart is only for context.
For a cash dividend to be qualified, it must meet two general requirements imposed by the IRS:
Distributed by a US corporation or qualified foreign corporation*
The investor must meet a specific unhedged** holding period***
*To be considered a qualified foreign corporation, it must meet any one of the following requirements:
Incorporated in a US possession (including territories like Puerto Rico)
Subject to a US tax treaty
The dividend-paying security trades on an established stock exchange (e.g. an American Depositary Receipt trading on the NYSE)
**Unhedged means unprotected. An unhedged position does not have any insurance or another related product (e.g. a long put hedge) that would prevent the investor from experiencing a loss.
***The holding periods established by the IRS are a bit bizarre and are unlikely to be tested (knowing a holding period requirement exists for a dividend to be qualified should suffice). For example, the holding period for common stock dividends requires the stock to be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
If a dividend is not qualified, it’s taxed as a non-qualified (ordinary) dividend. The tax rate equals the investor’s federal marginal income tax bracket (the rate applied to the last dollar earned). As of tax year 2025, these are the income tax brackets for individuals and those filing jointly:
Rate
Individuals
Married filing jointly
10%
$0
$0
12%
$11,926
$23,851
22%
$48,476
$96,951
24%
$103,351
$206,701
32%
$197,301
$394,601
35%
$250,526
$501,051
37%
$626,351
$751,601
Do not memorize these tax brackets; this chart is only for context.
Your federal income tax bracket determines the tax rate you pay on non-qualified dividends. Qualified dividends generally create a lower tax obligation.
For example, assume an individual earning $50,000 receives a $100 dividend:
If the dividend is qualified, the tax rate is 15% (from the qualified dividend table above), so the tax is $15 ($100 x 15%).
If the dividend is non-qualified, the tax rate is 22% (from the marginal income tax bracket table above), so the tax is $22 ($100 x 22%).
In most exam scenarios, you can assume common stocks, preferred stocks, and mutual funds pay qualified dividends unless the question says otherwise. One common dividend-paying investment is an exception: Real estate investment trust (REIT) dividends are always non-qualified (taxable up to 37%). Because REIT dividends can be taxed at higher rates, REITs generally need to offer higher returns to attract investors.
Dividends are reported annually on Form 1099-DIV, which brokerage firms prepare and send to both customers and the IRS. The form shows the dividends received and whether they were qualified or non-qualified.
A dividend must be paid during the year to appear on that year’s 1099-DIV. For example, if a dividend is declared in 2025 but paid in 2026, it’s reported on the 2026 1099-DIV.
Interest
Interest is income received from a debt instrument (like a bond). When you buy a bond, you’re lending money to an organization in exchange for interest payments.
Unlike dividends, interest generally isn’t taxed at favorable rates. However, depending on the issuer, some taxes may be avoided.
As a reminder, here’s the tax status of different types of bond issuers:
If taxes are due, the applicable tax rate equals the investor’s federal marginal income tax bracket (shown in the chart above). Interest is taxed the same way as non-qualified dividends.
