Dividends & interest

Much of the material in this chapter reviews earlier chapters, but you’ll also see some new topics. Read the entire chapter so you don’t miss anything.

When you invest, taxes affect what you keep after earnings. This chapter focuses on the tax treatment of dividends and interest.

Dividends

A cash dividend is income received from common or preferred stock. Investors can also receive dividends from funds (e.g., mutual funds) that pass through income earned by the investments in the fund’s portfolio.

Dividends are typically taxed at lower rates than other types of investment income (for example, 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 increases, the tax rate increases. That structure is called a progressive tax (discussed further below).

Dividends are either qualified or non-qualified, and that classification determines how they’re taxed. Qualified dividends are taxed at lower rates than non-qualified (ordinary) dividends.

Here’s the general breakdown:

Qualified dividend tax rates

• 0% (low income)
• 15% (moderate income)
• 20% (high income)

Test questions about tax brackets are often generalized because brackets change over time. Still, here are the specific brackets for investors filing single and married filing jointly (tax year 2025):

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 unusual and are unlikely to be tested (it’s usually enough to know that a holding period requirement exists for a dividend to be qualified). 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 applicable tax rate equals the investor’s federal marginal income tax bracket, which is the highest rate that applies to the taxpayer’s income. As of tax year 2025, these are the income tax brackets for individuals and those filing jointly:

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 always create a lower tax obligation.

For example, assume an individual with $50,000 of annual income receives a $100 dividend:

• If the dividend is qualified, the investor uses the qualified dividend table above and pays 15%, or $15 ($100 x 15%).
• If the dividend is non-qualified, the investor uses the marginal income tax bracket table above and pays 22%, or $22 ($100 x 22%).

On the exam, you can usually assume common stocks, preferred stocks, and mutual funds pay qualified dividends unless the question says otherwise.

One 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 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:

US Government debt

• Subject to federal taxes
• Exempt from state and local taxes

Municipal debt

• Exempt from federal taxes
• Subject to state and local taxes
• 100% tax-free for residents

Corporate debt

• Subject to federal, state, and local taxes

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.