A dividend is the percentage of profits that companies give back to their stock holders periodically. People who own things like mutual funds, stocks, and bonds will be the ones who receive dividends. One thing to be aware of is that there are two different kinds of dividends. This is very important to know because they are taxed differently.
There are “ordinary dividends”, which are taxed at the “normal tax rate”. Then there are “qualified dividends” which are taxed as “net capital gains”. Let’s take a look into what the difference is between ordinary and qualified dividends, and how it relates to you. This information will help you decide when to buy or sell certain stocks in order to maximize your profit and minimize your tax liability. You will also get some insightful advice on how to manage your portfolio when it comes to taxes.
Ordinary dividends are taxed as normal income. This means that your normal tax rate (percentage) can keep raising as you make more money. These are usually how short term investors that buy and sell stocks frequently would be taxed. You should consult the current IRS tax rate schedule, for the most accurate and up to date tax rates. The regular tax rate is the tax rate that everybody is charged, there is really not a way to change it, unless all of your earnings are qualified dividends.
Qualified dividends are taxed as “net capital gains” which carry a much lower tax rate than ordinary dividends. Qualified dividends are what long term investors would have. To be considered a qualified dividend, you need to have held the stock for more than 60 days out of the 121 day period before the last set of dividends was paid out to the shareholders.
The much lower tax rate that was mentioned earlier is either going to be 5% or 15%, depending on your regular tax rate. The rule that separates the percentages is based on your regular tax rate for ordinary income. The IRS sets the ‘split point’ at a 25% regular tax rate. This means that if your regular tax rate is less than 25%, then your qualified dividend tax rate is 5%. Of course, if it was over 25% you would be taxed at a 15% tax rate on these particular dividends.
The best time to buy and sell certain stocks can become more clear by considering the differences between these two different types of dividends as seen through the eyes of the IRS. You can easily control your tax liabilities by hanging on to stocks for longer periods of time. However, if you want to flip penny stocks for the big bucks and fast cash, you will not be hanging on to the stocks long enough to get the “qualified dividend” rate. Though flipping stocks can build profits quickly, it also raises your “tax rate” just as fast. If you want to make money with penny stocks, there are many tools out there that will help you make the trades at the right time. If you want to have steady payments coming in from your stocks, you can hang on to them for a longer time and qualify for the lower tax rate that the qualified dividend offers.
Most smart investors use a mixture of both short term and long term investments. Some use the “short term investment” profits which are taxed at the “regular tax rate” to feed the “long term investments” which would be be taxed at the “lower tax rate” as qualified dividends. Of course, if you are quickly flipping stocks, then you will not be likely to get paid any dividends to begin with, but if they pay dividends while you are waiting to sell then you might consider hanging on to it a little longer to get the lower tax rate that comes with qualified dividends.