Ordinary Dividends

Ordinary dividends are the whole of what a corporation or fund paid a shareholder out of earnings and profits during the year, counted before any part of it is separated out for the lower tax rate. Qualified dividends are a subset of that total rather than a second amount sitting beside it.

Getting that relationship backwards is the most expensive mistake on this subject, and the form is built in a way that invites it.

Box 1a Already Contains Box 1b

Box 1a of Form 1099-DIV takes dividends, including dividends from money market funds, net short-term capital gains from mutual funds, and other distributions on stock, and it includes reinvested dividends and section 404(k) dividends paid directly from the corporation. Box 1a includes the amounts entered in boxes 1b and 2e, and it also includes the recipient’s share of investment expenses reported in box 6 (IRS, Instructions for Form 1099-DIV, Rev. January 2024).

Box 1b is defined against it. It takes the portion of the dividends in box 1a that qualifies for the reduced capital gains rates (IRS, Instructions for Form 1099-DIV, Rev. January 2024).

Say a client’s Form 1099-DIV shows the amounts below.

Box 1a, total ordinary dividends              4,000
Box 1b, qualified dividends                   3,200
                                              -----
Dividends reported                            4,000
  of which taxed at the lower rate            3,200
  of which taxed at ordinary rates              800

The dividends reported are the box 1a figure alone. Box 1b is a description of part of box 1a, so adding the two lines counts the same money twice, and a return prepared that way overstates the client’s investment income.

Where those two figures land on the return, and why the label ordinary is doing two different jobs, is set out in ordinary income.

What Makes a Dividend Qualified

The statute starts wide and then cuts. Qualified dividend income means dividends received during the taxable year from domestic corporations and from qualified foreign corporations (26 U.S. Code section 1(h)(11)(B)(i)).

Three categories are then excluded outright: a dividend from a corporation that is exempt from tax under section 501 or 521 for the year of the distribution or the preceding year, an amount allowed as a deduction under section 591 for dividends paid by mutual savings banks, and any dividend described in section 404(k) (26 U.S. Code section 1(h)(11)(B)(ii)).

A foreign corporation qualifies if it is incorporated in a possession of the United States, or is eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory and that includes an exchange of information program. A foreign corporation meeting neither test is still treated as qualified for a dividend where the stock it is paid on is readily tradable on an established securities market in the United States (26 U.S. Code section 1(h)(11)(C)).

The Test That Actually Fails Is the Clock

Qualified dividend income does not include a dividend on any share of stock where the holding period requirements of section 246(c) are not met, read by substituting 60 days for 45 days and a 121-day period for a 91-day period (26 U.S. Code section 1(h)(11)(B)(iii)).

The form instructions state the same rule in days a preparer can count. A dividend is not qualified where the recipient held the share for less than 61 days during the 121-day period that began 60 days before the ex-dividend date, and days on which the recipient’s risk of loss was diminished cannot be counted. The ex-dividend date is the first date following the declaration on which a purchaser is not entitled to the next dividend payment, and when counting, include the day the stock was disposed of but not the day it was acquired (IRS, Instructions for Form 1099-DIV, Rev. January 2024).

Preferred stock runs on a different clock where the dividend is attributable to periods totaling more than 366 days. There the share has to be held at least 91 days during the 181-day period beginning 90 days before the ex-dividend date, and preferred dividends attributable to periods totaling less than 367 days fall back to the 61-day rule (IRS, Instructions for Form 1099-DIV, Rev. January 2024).

This is the rule a position traded near the ex-dividend date fails, and the client never sees the arithmetic, because it happens inside the payer’s box 1b figure rather than on the return.

What Is Never Qualified

The instructions list the rest, and each entry is a real client situation.

• Dividends that relate to payments the recipient is obligated to make on short sales or on positions in substantially similar or related property (IRS, Instructions for Form 1099-DIV, Rev. January 2024).
• Dividends paid by a regulated investment company that are not treated as qualified dividend income under section 854 of the Code (IRS, Instructions for Form 1099-DIV, Rev. January 2024).
• Dividends paid by a real estate investment trust that are not treated as qualified dividend income under section 857(c) of the Code (IRS, Instructions for Form 1099-DIV, Rev. January 2024).
• Deductible dividends paid on employer securities (IRS, Instructions for Form 1099-DIV, Rev. January 2024).

The REIT line explains a result that surprises clients every year. A REIT distribution can be a large box 1a figure with almost nothing in box 1b, so the income arrives taxed at ordinary rates however long the shares were held.

Common Questions

Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can grade a real block of its own investment income work through a trial task before anything client facing depends on it.