Dividends

Taxes affect more than what you pay at the store. When you earn money from an investment, the government taxes those returns. The tax treatment depends on the type of security and the type of transaction. Because of that, taxes directly affect an investor’s overall return.

This unit covers common types of investment taxes, how they’re assessed, and how they affect investing. This chapter focuses on dividends.

A cash dividend is income received from an equity investment, including common and preferred stock. Investors can also receive dividends from packaged products (e.g., mutual funds, closed-end funds, ETFs) that pass through income earned by the investments held in their portfolios.

Dividends are typically taxed at lower rates than other forms of investment income (e.g., bond interest). The rate you pay depends on your annual taxable income, which can include all of the following forms of income:

• Salary
• Wages
• Commissions
• Bonuses
• Royalties

In general, as income increases, the applicable tax rate increases. Dividends are classified as qualified or non-qualified, and that classification determines how they’re taxed. Qualified dividends are taxed at lower rates than non-qualified dividends.

Here’s the basic 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 qualified dividend 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 in the US (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 bizarre and 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 applicable 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:

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 with $50,000 of annual income receives a $100 dividend:

• If the dividend is qualified, the investor uses the qualified dividend table and pays 15%, for a $15 tax obligation ($100 × 15%).
• If the dividend is non-qualified, the investor uses the marginal income tax bracket table and pays 22%, for a $22 tax obligation ($100 × 22%).

In most exam scenarios, you can assume common stocks, preferred stocks, and mutual funds pay qualified dividends unless the question states otherwise. However, one dividend-paying investment never pays qualified dividends: real estate investment trust (REIT) dividends are always considered non-qualified (taxable up to 37%). Because REIT dividends can be taxed at higher ordinary income rates, REITs generally need to offer higher returns to attract investors.

Dividends are reported annually on Form 1099-DIV. Brokerage firms send this form to customers and to the IRS. It shows the dividends received and whether they’re qualified or non-qualified. A dividend appears on the 1099-DIV for the year it’s paid. For example, if a dividend is declared in 2025 but paid in 2026, it’s reported on the 2026 1099-DIV.

Cash dividends are taxable, but stock dividends and splits are not. With a stock dividend or split, you receive more shares, but the share price adjusts proportionately. That means the total value of the position doesn’t change at the time of the distribution. The new shares aren’t taxable until they’re sold.