When it comes to owning stock, everyone deserves his or her slice of the pie in the form of a dividend, but that’s if the company pays one. Dividends come in all shapes and sizes, and they’re all treated differently from a tax perspective. 

Generally, cash dividends for a fully paid stock position (cash account) will appear on your Form 1099-DIV. However, if you have a margin account then a dividend payment may list on your 1099-MISC instead.

Cash Dividends

Taxes are inevitable with cash dividends, but they can be taxed differently based upon how long you have held the stock. Welcome to the world of ordinary dividends and qualified dividends.

Ordinary dividends, just as the name implies, are generally taxed the same way as your ordinary income tax rate. This applies to positions held for 60 days or less during the 121-day period that begins 60 days before and after the ex-dividend date.

On the other hand, dividends become qualified when the position is held for 61 days or more within the 121-day period. Why does this matter? Qualified dividends are generally assessed at a lower tax rate.

If you were confused by the last sentence, don’t worry. Admittedly it can get a little confusing in word form, so we attempted to visualize it below.

Example 1: Ordinary Dividends

• Purchase 100 XYZ on May 22nd
• Collect the dividend
• Close 100 XYZ on July 10th
• Position held for 49 days
• The $10 dividend payment ($0.10 x 100 qty) is treated as ordinary income.

Example 2: Qualified Dividends

• Purchase 100 XYZ on May 22nd
• Collect the dividend
• Close 100 XYZ on August 8
• Position held for 73 days
• The $10 dividend payment ($0.10 x 100 qty) is subject to a lower tax rate.

Example 3: Ordinary Dividends & Qualified Dividend

Example 4: Qualified Dividends

• Purchase 100 XYZ on May 22nd
• Collect the dividend
• The $10 dividend payment ($0.10 x 100 qty) is subject to long-term capital gains
• Position not closed
• Dividends that are automatically reinvested through DRIP, or Dividend Reinvestment Plan, are also subject to taxes and are treated according to the holding period.

Special Dividends

Some underlyings may issue a special dividend

If you were fortunate enough to get some extra love from your positions in the form of a special dividend, then Uncle Sam wants some of that love as well. Special dividends can fall into one of three categories: return on capital, long-term capital gains, and short-term capital gains (ordinary income).