Collecting dividend checks gives investors a way to earn passive income. While this may seem simple, the tax rules behind them are surprisingly complex. Whether you reinvest every cent or rely on dividends as a source of income, understanding how they’re taxed can help you avoid costly surprises and keep more earnings in your pocket. Read on to learn more about this.

What are dividends?

At the most basic level, stock dividends are a portion of a company’s profits paid out to shareholders. When you own stock in a dividend-paying company or shares in a mutual fund or ETF that holds said company, you’re entitled to your own share of those same profits.

Most companies pay cash dividends on a quarterly basis. For example, if you own 100 shares of a company that pays $0.50 per share each quarter, you’ll receive $50 every three months. Some companies also issue stock dividends that give shareholders extra shares rather than cash.

Dividends are common in well-established, historically profitable companies—think Coca-Cola or Procter & Gamble—and many investors rely on them as a steady income stream. Others, however, simply reinvest them into more shares: compounding growth over time. Cash dividends count as taxable income if they’re paid into a regular brokerage account (no matter how you use them), which is where things get a little complicated.

Qualified vs. ordinary dividends: a quick history lesson

Different types of dividends were previously treated the same way in the U.S., with all dividend payments taxed as ordinary income: creating a major issue for investors as it meant taxation per the highest income tax rates and that dividends were subject to double taxation.

After a corporation paid corporate income tax on its profits and after-tax profits were distributed to shareholders as dividends, shareholders paid tax on the very same money once again. This, in turn, made dividend-paying stocks less attractive than growth stocks that reinvested profits rather than paying them out. Why invest in a company that distributes heavily taxed dividends when you could instead buy a company that reinvests profits and grows share value instead?

This entire dynamic shifted with the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), often referred to as the “2003 Bush Tax Cuts.” Among its many impacts, the Act created a brand-new category of dividend income: qualified dividends.

What are qualified dividends?

Qualified dividends were initially designed to encourage investment in dividend-paying companies by making dividends less heavily taxed. They also rewarded long-term investors by applying lower long-term capital gains rates—rather than ordinary income rates—to certain dividends. Finally, they helped address the problem of double taxation by taxing dividends from already-taxed corporate profits at a lower rate.

To qualify for this lower rate, a U.S. corporation or qualified foreign company had to pay the dividend with the shareholder also fulfilling a holding period requirement (generally holding the stock for more than 60 days within a 121-day window surrounding the ex-dividend date). Any dividend that didn’t meet these requirements remained an ordinary dividend and was thus taxed at regular income tax rates.

Qualified vs. ordinary dividends today

The 2003 reform gave us two distinct dividend categories. While qualified dividends receive more favorable long-term capital gains tax rates, typically come from U.S. corporations or qualifying foreign companies, and feature the aforementioned holding period rule, ordinary dividends are those that don’t meet IRS criteria. They’re taxed at an ordinary income rate—the same rate you pay on wages or interest—and include dividends from real estate investment trusts (REITs), master limited partnerships (MLPs) (publicly traded entities taxed as partnerships), some foreign companies, and stocks held only for a brief period.

This split means that two investors earning the same dividend amount might see very different tax bills depending on the type of dividends received and how long they’ve held their investments.

Tax rates on ordinary and qualified dividends

The dividend tax rate depends on both the type of dividend and one’s tax bracket. Rates are set at long-term capital gains levels of 0%, 15%, or 20%—depending on your income—for qualified dividends, and investors with lower taxable income may pay nothing whereas high earners might owe the top rate.

Ordinary dividends, on the other hand, are taxed at one’s regular income tax rate (currently ranging from 10% to 37%). Another wrinkle for higher-income investors means those whose income exceeds a given threshold ($200,000 for single filers and $250,000 for married couples, as of 2025) may also owe the Net Investment Income Tax (NIIT): an additional 3.8% on dividends and other investment income.

Hypothetical examples of how dividends are taxed

Consider a few purely hypothetical scenarios to see these rules in action…

Example 1: A retiree with qualified dividends

Imagine a retired teacher (“Sarah”) earns $20,000 a year from Social Security and an additional $10,000 in qualified dividends from a portfolio of U.S. blue-chip stocks. Since her total taxable income is modest, her qualified dividends fall into the 0% tax bracket: meaning she owes no federal tax on them.

Example 2: A mid-career professional with mixed dividends

Now consider “Mark,” an engineer with a $90,000 salary who’s earned $5,000 in qualified dividends from a U.S. index fund and $2,000 in ordinary dividends from a REIT. Paying 15% on his qualified dividends ($750) and an ordinary income tax rate of roughly 22% on his REIT dividends (~$440), he collectively owes nearly $1,200 in federal tax on his $7,000 dividend income.

Example 3: A higher-income investor

Finally, we have “Angela,” a tech exec who earns $300,000 annually and has $50,000 in qualified dividends and $10,000 in ordinary dividends from investments. Her qualified dividends are taxed at 15% (for a $7,500 tax bill), with ordinary dividends taxed at 35% (an additional $3,500). Moreover, Angela owes 3.8% NIIT on all $60,000 of her investment income: adding roughly $2,280. In total, Angela pays over $13,000 in federal taxes on her dividend income.

Naturally, these simplified examples assume no deductions nor other tax complexities but are simply meant to illustrate how dramatically the tax treatment of dividends can vary depending on income level and whether dividends are qualified or ordinary.

How the IRS tracks dividends

Those who hold dividend-paying investments in a taxable brokerage account receive Form 1099-DIV each year, breaking down dividend income and displaying the total amount received (and how much was considered qualified versus ordinary). It also lists any capital gain distributions and any foreign taxes withheld. Even if dividends are automatically reinvested into additional shares rather than paid out in cash, the IRS still considers that income for the year and expects you to report it on your tax return.

How dividends are taxed based on account type

Where exactly you hold dividend-paying investments is the other factor impacting how much you’ll pay in subsequent taxes. This includes…

Brokerage accounts

If your investments are in a regular taxable brokerage account, you’ll owe taxes on dividends in the year they’re paid.

Traditional IRAs or 401(k)s

If those investments are part of a traditional IRA or a 401(k), dividends are sheltered as they’re earned and grow tax-deferred. You’ll only pay ordinary income tax later on when you begin taking withdrawals in retirement.

Roth accounts

Roth accounts are most generous overall in this respect, with tax-free dividends earned and no need to pay tax on that income if you follow qualified withdrawal rules—which is precisely why many long-term investors choose to hold dividend-paying investments in Roth accounts if they’re able to do so.

Dividend taxes: special and complex situations

Not all dividend income fits neatly into the qualified/ordinary mix.

Dividends from foreign companies, for example, may come pre-loaded with foreign tax withholding before they ever even hit your account. In many cases, you can claim a foreign tax credit to avoid double taxation (though it requires extra paperwork).

Some investments—like REITs and MLPs—produce dividends or distributions that almost never qualify for lower rates, with payouts generally taxed as ordinary income and sometimes accompanying complex reporting forms (e.g., K-1s). Mutual funds and ETFs can also pass along capital gain distributions (in addition to dividends) which aren’t technically dividends but show up on the same 1099-DIV form and can potentially increase your tax bill.

How to manage dividend taxes

While dividend taxes are unavoidable in many situations, there are ways to minimize their impact including…

Holding stocks in tax-advantaged accounts

One strategy is to hold dividend-paying stocks and funds in tax-advantaged accounts (e.g., IRAs or Roth accounts) so income is either tax-deferred or tax-free.

Focusing on qualified dividends

You can also focus on investments that pay qualified dividends as those are taxed at lower rates than their ordinary counterparts.

Holding on to stocks a little longer

Investors should also pay close attention to how long they hold some stocks as selling too quickly can disqualify a dividend from the lower tax rate. For taxable accounts, techniques such as tax-loss harvesting can help lower one’s overall tax bill.

Even seemingly modest choices, such as holding REITs inside an IRA or keeping low-dividend stocks in taxable accounts, can add up over time.

The takeaway: how dividends are taxed

Knowing how qualified and ordinary dividends are taxed and strategically placing your investments in the most advantageous accounts can help limit your tax burden and maximize the income that stays in your pocket. As tax situations vary widely from person to person, however, another smart move is to consult with a qualified tax advisor or financial planner to ensure your dividend strategy aligns with your own unique financial goals.

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How Dividends Are Taxed: What Investors Need to Know