Are Non-Qualified Dividends Really Taxable? Avoid this Mistake + FAQs

Yes, non-qualified dividends are fully taxable at ordinary income tax rates.

This means any dividend that does not meet the IRS criteria for “qualified dividends” will be taxed just like regular wages or interest income.

There is no special tax break for these payouts – they are added to your taxable income for the year and taxed according to your marginal tax bracket.

Non-qualified dividends often come from sources like Real Estate Investment Trusts (REITs), certain foreign companies, or even U.S. stocks you didn’t hold long enough to qualify for the lower rate. Understanding how these dividends work is essential for tax planning.

(The IRS defines whether a dividend is qualified or not for tax purposes, whereas the SEC – Securities and Exchange Commission – oversees how companies report and distribute dividends to investors.)

What Are Non-Qualified Dividends?

Non-qualified dividends (sometimes called ordinary dividends) are corporate profit distributions that do not meet the IRS’s requirements to be taxed at the lower qualified dividend rate.

In other words, these are dividends that get no special tax break – they are taxed just like your regular income.

To contrast, qualified dividends do meet specific criteria (for example, they’re paid by a U.S. or qualifying foreign corporation and you held the stock for a required minimum period).

Qualified dividends are rewarded with lower tax rates (the same preferential rates as long-term capital gains). Any dividend that fails to meet those criteria is simply non-qualified and taxed at ordinary income rates.

Examples of Non-Qualified Dividends:

• Dividends from a REIT (Real Estate Investment Trust) or certain mutual funds that don’t hold stocks long enough to pass through qualified status.

• Dividends from foreign companies not qualified under IRS rules (for instance, companies in countries without a U.S. tax treaty or not traded on U.S. exchanges).

• Dividends from stocks you held only briefly, failing the required holding period. (Generally, if you hold the stock less than 61 days around the ex-dividend date, the dividend is non-qualified.)

For all these cases, the result is the same: the dividend doesn’t get the special low tax rate. These payouts are fully taxable at your normal rate.

On tax forms, non-qualified dividends aren’t explicitly labeled as “non-qualified.” Instead, your brokerage reports total ordinary dividends (which includes all dividends) in Box 1a of Form 1099-DIV, and then shows the subset that are qualified dividends in Box 1b.

For example, if Box 1a shows $500 in total dividends and Box 1b shows $300 as qualified, the remaining $200 are non-qualified dividends (taxable at standard rates).

U.S. Federal Taxation of Non-Qualified Dividends

Under U.S. federal tax law, non-qualified dividends are taxed as part of your ordinary income. This means they simply increase your taxable income for the year, and you pay whatever marginal tax rate applies to that income slice.

The IRS currently has federal income tax brackets ranging from 10% up to 37% for individuals (the higher your total income, the higher the rate on the top portion of your income).

For example, if you’re in the 22% tax bracket, a $100 non-qualified dividend will incur $22 of federal tax. In contrast, a $100 qualified dividend might only incur $15 of tax if you’re in that same bracket (because qualified dividends get the lower capital gains rate). This illustrates how non-qualified dividends can carry a heavier tax burden.

Crucially, non-qualified dividends do not benefit from any exclusive tax exemptions. They are fully taxable from the first dollar (aside from general allowances like your standard deduction). If your overall income is low enough, you might pay little to no tax simply because you fall in a low bracket.

However, there’s no special 0% rate band for non-qualified dividends like the one that qualified dividends and long-term capital gains enjoy at lower income levels.

If you have significant dividend income, note that it can potentially push you into a higher tax bracket. Moreover, high-income individuals must consider the 3.8% Net Investment Income Tax (NIIT). This surtax kicks in when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). The NIIT applies to investment income like dividends, meaning an affluent taxpayer could effectively pay 40.8% on non-qualified dividends at the top end (37% regular + 3.8% NIIT).

Reporting: Non-qualified dividends are reported on your Form 1040 just like any other income. If your total dividends (plus interest) exceed $1,500, you’ll also file Schedule B to list your sources. But unlike qualified dividends (which are noted separately for tax calculations), non-qualified amounts don’t require a special worksheet – they’re already included in your ordinary income on the tax return. Essentially, you add up all your income (including these dividends) and calculate tax using the normal tax tables.

Historical note: Before 2003, all dividends were taxed at ordinary income rates. The introduction of qualified dividends (via the 2003 tax law changes) carved out a portion of dividends for lower tax treatment. However, any dividends that remain “non-qualified” continue to be taxed under the standard federal rates just as they always have been.

C Corporations: Taxation of Non-Qualified Dividends

A C corporation (a regular corporation that pays corporate taxes) receiving non-qualified dividends has a different set of rules. Corporations pay tax on their taxable income at a flat federal rate (21% as of recent law).

When a C corp includes dividend income (from stocks it owns) in its profits, those dividends are generally taxable to the corporation as ordinary income. However, C corps get a special break called the Dividends Received Deduction (DRD) on dividends they receive from other taxable U.S. corporations. This deduction exists to prevent multiple layers of tax when profits move from one corporation to another.

How the DRD works: If a C corp owns less than 20% of the company paying the dividend, it can typically deduct 50% of the dividend received. If it owns 20% or more (but less than 80%), it can deduct 65%. Owning 80% or more usually allows a 100% deduction (essentially making inter-company dividends tax-free within a corporate group). For example, if Corporation X (a C corp) receives a $10,000 dividend from stock it holds in another company (and it owns a small stake), it might deduct $5,000 and only pay corporate tax on the remaining $5,000. At a 21% corporate tax rate, that’s $1,050 of tax on the $10,000 dividend. This effective rate (about 10.5%) is much lower than what an individual might pay on the same non-qualified dividend.

It’s important to note that not all dividends a corporation receives qualify for the DRD. Dividends from investments like REITs or from certain mutual funds are generally not eligible for the DRD. Those would be fully taxable to the corporation at the normal 21% rate. Additionally, dividends from foreign corporations may not qualify unless certain conditions are met.

Finally, remember that when a C corporation pays out dividends to its own shareholders, those dividends (whether qualified or not to the shareholders) are not deductible to the corporation. The corporation pays tax on its profits first, and then shareholders pay tax again on the dividends they receive, resulting in the well-known double taxation of corporate earnings. The DRD softens this for corporate-to-corporate dividends, but once the money reaches an individual shareholder, that individual faces tax on the dividend (at ordinary rates if it’s a non-qualified dividend).

S Corporations & Partnerships: Pass-Through Dividend Taxation

S corporations and partnerships (including LLCs treated as partnerships) generally do not pay income tax at the entity level. Instead, they pass through all income to their owners or shareholders. This pass-through income retains its character for tax purposes. So, if an S corp or partnership receives non-qualified dividends (say from stocks or funds it owns), it will report that income to its owners, and the owners will pay tax on those dividends on their own returns.

For example, suppose an S corporation owns shares in a REIT that pays a $1,000 dividend (non-qualified). The S corp itself doesn’t pay tax on that $1,000. Instead, it will issue a Schedule K-1 to each shareholder allocating their share of the $1,000 dividend. The shareholders include that amount on their personal tax returns (taxed at their ordinary income rate, since it’s a non-qualified dividend). Similarly, partnerships allocate dividends to partners on a K-1, and those partners pay tax individually.

One key point: the qualification of a dividend (for the lower rate) can also pass through if it meets the requirements. If the partnership or S corp received a qualified dividend and held the stock long enough, the K-1 will report it as a qualified dividend to the owner, allowing the owner to use the lower tax rate. Conversely, non-qualified dividends remain ordinary income on the K-1. Essentially, the entity acts as a conduit.

For S corp owners and partners, this means you should look at your K-1 forms: they will typically break out the portions of dividend income that are qualified vs. non-qualified. In summary, non-qualified dividends from an S corp or partnership are taxed to you, the owner, at your regular tax rates – just as if you received them directly.

One advantage of pass-through treatment is that there’s no second layer of corporate tax. Income like non-qualified dividends isn’t taxed at the entity level first, unlike in a C corp. This avoids the double taxation issue. However, you still don’t get any special tax rate on the non-qualified dividend income itself, so your personal tax outcome is the same as if you held the investment personally.

Trusts and Estates: Taxation of Non-Qualified Dividend Income

Trusts and estates can also receive dividend income, and they have their own tax rules. Trusts (and estates during administration) often pay tax on income at very compressed brackets – reaching the top 37% federal rate at around ~$14,000 of income. Non-qualified dividends received by a trust are taxable as ordinary income, just like for individuals, but the trust hits high tax rates with much less income.

However, many trusts distribute income to beneficiaries. When a trust distributes dividend income (via its accounting income or DNI – distributable net income), that income is generally taxed to the beneficiary instead of the trust. The beneficiary would then pay tax on those dividends at their own tax rates. If the dividends are non-qualified, the beneficiary pays at ordinary rates. If some are qualified, the trust’s K-1 to the beneficiary will specify that portion so the beneficiary can use the lower rate on that part.

If a trust retains the dividend income (doesn’t distribute it), the trust itself pays the tax. For non-qualified dividends, the trust will pay ordinary income tax, which, as noted, can be at 37% federal very quickly for a modest amount of income. Trusts also face the 3.8% NIIT surtax on investment income at a low threshold (around the top of that ~$14k bracket). This means a trust that accumulates a significant non-qualified dividend could be taxed at over 40% on that income federally.

In practice, trustees often elect to distribute income to beneficiaries in lower tax brackets to avoid the trust paying high rates. From a planning perspective, if you’re a beneficiary, understand that a trust’s non-qualified dividend income might come to you on a Schedule K-1. You’ll then report it on your return and pay tax at your rates.

Estates during probate or administration are taxed similarly to trusts. They can distribute income to heirs (beneficiaries) or retain it. Any non-qualified dividends kept by the estate are taxed to the estate at the estate’s tax rates (which are the same brackets as trusts, reaching high rates quickly). If passed out to heirs, the heirs pay the tax at their own rates.

Non-qualified dividends don’t get any special break in trusts or estates. The strategy is usually to push that income out to someone (an individual beneficiary) who might pay less tax, rather than having it taxed within the trust or estate at the top rates.

State Taxation of Non-Qualified Dividends

State taxes on dividends vary, but in general, states tend to treat all dividends as ordinary income, just like the federal government treats non-qualified dividends. This means that whether a dividend was “qualified” or not doesn’t usually matter for state tax purposes – it’s taxed at the state’s normal income tax rates.

If you live in a state with an income tax, you will likely pay state tax on your dividend income (both qualified and non-qualified) at the same rates that apply to your other income. States typically do not provide a lower capital gains rate for dividends like the federal government does for qualified dividends. For example, California taxes dividend income at rates up to 13.3% (its highest ordinary income tax rate), and New York taxes dividends up to around 10% at the top bracket. So a high-earning individual in those states could see a substantial state tax hit on dividends (on top of federal tax).

On the other hand, several states have no personal income tax at all. Florida, Texas, Nevada, Washington, Alaska, South Dakota, Wyoming – residents of these states pay 0% state tax on dividends (since there’s no state income tax). In these states, only federal taxes (and any applicable federal surtaxes like the NIIT) apply to your dividend income.

There have also been unique cases: Tennessee and New Hampshire historically taxed dividends and interest even though they had no tax on wage income. Tennessee’s tax (the Hall Tax) was phased out fully by 2021. New Hampshire still imposes a tax on interest and dividends (at 5% in recent years), but it is set to phase out by 2027. Aside from those, nearly all states either tax dividends as part of general income or not at all if they lack an income tax.

It’s worth checking your own state’s rules, as a few states offer partial exclusions or credits for certain types of income (for instance, some states have exemptions for senior citizens’ investment income or specific deductions that could indirectly affect dividend taxation). But broadly, non-qualified dividends face the same state tax treatment as any other income: no special breaks, and state tax rates ranging from 0% (in no-tax states) to some of the highest combined rates in states like California or New York.

Keep in mind that state taxes are in addition to federal taxes. When planning for the tax impact of non-qualified dividends, consider both levels. In a high-tax state, the combined federal + state hit on a non-qualified dividend can exceed 40-50% at the top end, whereas in a no-tax state, you’d only be looking at the federal portion.

Qualified vs. Non-Qualified Dividends: Key Tax Differences

It’s important to understand side-by-side how qualified dividends differ from non-qualified dividends in taxation. Here’s a quick comparison:

As you can see, qualified dividends enjoy a tax advantage federally, whereas non-qualified dividends are fully taxable at higher rates. The gap in tax rates can significantly affect your after-tax return on investment, especially for large dividend amounts or high-income taxpayers. Planning which investments to hold in taxable vs. tax-advantaged accounts can help manage this difference.

📊 Examples: Tax on Non-Qualified Dividends in 3 Scenarios

To bring these concepts to life, let’s look at three common scenarios and see how non-qualified dividends are taxed compared to qualified dividends or other situations:

Scenario 1: Low-Income Individual (Small Dividend Income)

Situation: Alice is a single filer with $30,000 of other taxable income (after deductions) and receives a $1,000 dividend from her investment.

• If the $1,000 is a qualified dividend, it falls in Alice’s 0% capital gains bracket (since her taxable income is relatively low). Federal tax owed on the dividend: $0.

• If the $1,000 is a non-qualified dividend, it’s taxed at her ordinary income rate. With $30k of other income, Alice is in roughly the 12% federal bracket. Federal tax owed on the dividend: about $120 (12%).

• State tax: If Alice lives in a state with, say, a 5% income tax, she’d pay ~$50 state tax on that $1,000 dividend regardless of it being qualified or not (states tax both the same). In a no-income-tax state, state tax would be $0.

Result: In this scenario, a non-qualified dividend costs Alice about $120 more in federal tax than a qualified dividend of the same amount. At low income levels, qualified dividends can be entirely tax-free federally, whereas non-qualified are still taxed at the normal rate.

Scenario 2: High-Income Individual in a High-Tax State

Situation: Bob is a high earner (top tax bracket) living in California. He has a high salary putting him in the 37% federal bracket (and subject to the 20% qualified dividend rate). Bob receives $10,000 in dividends from various stocks.

• If the $10,000 is qualified dividends, Bob pays 20% federal tax = $2,000. (If he’s over the NIIT threshold, an additional 3.8% NIIT could apply, but we’ll focus on base rates.) California will also tax this income at its top ~13% state rate = $1,300. Total tax ~$3,300 on $10,000.

• If the $10,000 is non-qualified dividends, Bob pays 37% federal tax = $3,700. State tax remains $1,300 (CA doesn’t care about qualification). Total tax ~$5,000 on $10,000.

• Difference: Bob’s non-qualified dividends incurred about $1,700 more tax than if they had been qualified. (And if we included the NIIT, the gap would be even larger.) Combined federal and state tax on non-qualified dividends for a top-bracket Californian can be roughly 50% of the dividend.

Result: For a high-income taxpayer in a high-tax state, non-qualified dividends can lose about half their value to taxes, whereas qualified dividends would be taxed at a significantly lower effective rate (around one-third in Bob’s case).

Scenario 3: Taxable Account vs. Retirement Account (Tax-Deferred Growth)

Situation: Carol has $5,000 in annual non-qualified dividend income from various investments. She’s in the 24% federal tax bracket.

• If held in a taxable brokerage account: Each year, Carol must pay taxes on that $5,000. Federally at 24%, that’s $1,200 in tax annually (plus any state tax). She keeps the remaining $3,800. Over time, paying tax yearly reduces how much of those dividends she can reinvest.

• If held in a tax-deferred account (Traditional IRA/401k): Carol doesn’t pay any tax on the dividends in the year they are earned. The full $5,000 can be reinvested. She will eventually pay tax when she withdraws funds from the account (at her ordinary rate then), but deferring tax allows the dividends to compound pre-tax. (If it’s a Roth IRA, she’d pay no tax on qualified withdrawals, making the dividends effectively tax-free.)

• Outcome over time: By not losing $1,200 a year to taxes, Carol’s retirement account can grow faster with those reinvested dividends. In a taxable account, the drag of annual taxes means she’d accumulate wealth more slowly. This example highlights why placing high-taxed dividend investments in an IRA or 401k can be advantageous.

These scenarios show that the tax impact of non-qualified dividends can vary widely. Low-income investors might see a small tax difference (or none, if qualified dividends fall in the 0% bracket), while high-income investors face a big gap. Using retirement accounts to shelter non-qualified dividends can mitigate their tax bite. Always consider your income level and account type when evaluating the after-tax return of dividend-paying investments.

Pros and Cons of Receiving Non-Qualified Dividends

While dividends are generally welcome by investors as a form of income, non-qualified dividends come with some distinct advantages and disadvantages to consider:

Overall, receiving non-qualified dividends can be a double-edged sword: you get the benefit of cash flow (and sometimes higher yields), but you’ll give up a larger chunk to taxes compared to qualified dividends. Investors often weigh these pros and cons when deciding on investment types or where to hold them (taxable vs. retirement accounts).

Avoid These Common Mistakes 🚫

Even savvy taxpayers can slip up when dealing with dividend taxes. Here are some common mistakes to avoid with non-qualified dividends:

• Assuming all dividends are taxed at the lower rate: It’s a mistake to think every dividend gets the favorable tax rate. In reality, ordinary (non-qualified) dividends are taxed at regular rates. Always check your 1099-DIV to see how much of your dividends are qualified vs. non-qualified.

• Ignoring holding periods and criteria: If you sell a stock too soon after buying it (or don’t meet the holding period), its dividend that you received might lose qualified status and become fully taxable. Don’t overlook the IRS’s holding period rule if you’re aiming for the lower tax rate.

• Reinvesting dividends without planning for taxes: Automatically reinvesting dividends (DRIP) can be a great strategy, but remember that reinvested dividends are still taxable each year. Don’t forget to set aside money or increase withholding to cover the tax on those dividends, even if you didn’t pocket the cash.

• Not using tax-advantaged accounts for high-tax dividends: Keeping REITs or other high-yield, non-qualified dividend payers in a regular taxable account can lead to big tax bills. A common mistake is not placing these investments in a Roth IRA, Traditional IRA, or 401(k) where their dividends can grow without immediate tax.

• Missing small dividends on your tax return: Even if a dividend is small (under $10 and no 1099-DIV was issued), it’s still technically taxable. Some taxpayers mistakenly omit these tiny amounts. While the IRS might not chase a few dollars, it’s good practice to report all income.

• Trust/estate distribution missteps: If you’re a trustee, a mistake is retaining income (like non-qualified dividends) inside the trust when it could be distributed to beneficiaries in lower brackets. This can cause unnecessary tax at the trust’s high rate. Coordinate distributions to minimize the overall tax hit.

By being mindful of these pitfalls, you can avoid overpaying taxes or facing surprises. Proper planning—such as timing stock sales, allocating assets to the right accounts, and reviewing tax forms—goes a long way in managing non-qualified dividend taxes efficiently.

FAQ: Non-Qualified Dividends and Taxes

Q: Do I have to pay taxes on non-qualified dividends if I reinvest them?
A: Yes. Reinvested dividends are still taxable in the year received. Using a DRIP doesn’t avoid tax; it just means you’re buying more stock with after-tax dividend money.

Q: How can I reduce or avoid taxes on non-qualified dividends?
A: Hold those dividend-paying assets in tax-advantaged accounts like an IRA or 401(k). In a regular account, there’s no way to avoid taxes on non-qualified dividends aside from offsetting them with losses or deductions.

Q: Are non-qualified dividends taxed twice?
A: Regular corporate dividends face double taxation: the company pays tax first, and then you pay tax on the dividend. Pass-through entities like REITs pay no corporate tax, so their dividends are only taxed once to you.

Q: How do I know if a dividend is qualified or non-qualified?
A: Check Form 1099-DIV from your broker. Box 1b shows the amount of qualified dividends. Any dividend amounts in Box 1a that aren’t in 1b are non-qualified (taxed at ordinary rates).

Q: Do states tax dividends differently if they’re qualified?
A: Generally no. States tax most dividends as regular income regardless. You’ll pay the same state tax whether a dividend is qualified or not (except in states with no income tax).

Q: Will non-qualified dividends push me into a higher tax bracket?
A: Potentially, yes. Non-qualified dividends add to your taxable income. If you receive a large amount, it could bump you into a higher federal bracket or trigger taxes like the NIIT.

Q: What happens to non-qualified dividends in an IRA or 401(k)?
A: Inside a tax-deferred account, you pay no tax on dividends as they’re earned. They compound tax-free until withdrawal (when they’re taxed as ordinary income). In a Roth IRA, they’d be completely tax-free.

Q: Are qualified dividends always better than non-qualified dividends?
A: Tax-wise, yes – qualified dividends are taxed at a lower rate. But some investments (like REITs) pay non-qualified dividends yet offer high yields or other benefits. It depends on your goals and tax situation.

Q: Do I need to make estimated tax payments on dividend income?
A: If you expect to owe over $1,000 in tax on dividends (and other income), make quarterly estimated payments or adjust your wage withholding to avoid an underpayment penalty.

Q: Where can I learn more about dividend taxation?
A: The IRS website (see IRS Topic 404 or Publication 550) provides details on dividends. Also, consult a tax advisor or CPA for personalized guidance, especially if you have substantial dividend income or complex situations.