What Is an Ordinary Dividend and How Is It Taxed?
Navigate the world of ordinary dividends. Learn their definition, how they're taxed as regular income, and their distinction from other payouts.
Dividends represent a portion of a company’s profits distributed to its shareholders. However, not all dividends are treated the same for tax purposes, and understanding these distinctions is important for investors. This article clarifies what constitutes an “ordinary dividend” and explains its tax implications.
What Defines an Ordinary Dividend
An ordinary dividend is a distribution of a company’s earnings and profits to its shareholders. These dividends are typically paid by most corporations and originate from their accumulated net income. Companies often distribute these earnings regularly, such as quarterly or annually, providing a consistent income stream.
These distributions are considered “ordinary” by default unless they meet specific criteria to be classified differently by the Internal Revenue Service (IRS). They are the most common type of dividend income investors receive from taxable corporations.
How Ordinary Dividends Are Taxed
Ordinary dividends are subject to an individual’s standard income tax rates, like wages or interest income. These rates vary depending on a taxpayer’s overall income and filing status, potentially ranging from 10% to 37% for the 2025 tax year. This means the tax liability on ordinary dividends aligns with the taxpayer’s marginal income tax bracket.
Ordinary dividends do not receive this preferential tax treatment, unlike other dividend types. In addition to federal income tax, ordinary dividends may also be subject to state and local taxes, depending on the taxpayer’s location.
Understanding Other Types of Dividends
Beyond ordinary dividends, other forms of distributions exist, each with unique tax implications. A distribution classified as an ordinary dividend can sometimes become a “qualified dividend,” which is taxed more favorably.
Qualified dividends are paid by a U.S. corporation or a qualifying foreign corporation, and the stock must be held for a specific period. For common stock, this holding period requires holding shares for more than 60 days within a 121-day period that begins 60 days before the ex-dividend date. If these conditions are met, qualified dividends are taxed at the lower long-term capital gains rates (0%, 15%, or 20%, depending on income level).
Return of capital distributions represent a different category; these are not paid from a company’s earnings and profits but rather reduce the investor’s original cost basis in the stock. These distributions are generally not taxed until the investor’s cost basis in the stock is reduced to zero. Once the basis reaches zero, any subsequent return of capital distribution is then taxed as a capital gain. Other less common distributions, such as stock dividends or capital gain distributions from mutual funds, also exist and have their own distinct tax treatments separate from cash dividends derived from corporate earnings.
Receiving and Reporting Dividends
Taxpayers receive information about their dividend income on Form 1099-DIV, “Dividends and Distributions.” This form is issued by financial institutions and provides a detailed breakdown of various types of distributions received during the year. Specifically, the total amount of ordinary dividends is reported in Box 1a of Form 1099-DIV.
This form is essential for accurate tax preparation, as it details the income that must be reported to the IRS. While taxpayers do not file Form 1099-DIV directly with their tax return, the information contained within it is used to complete their income tax forms. The IRS uses the data from Form 1099-DIV to verify the dividend income reported by individuals, ensuring compliance with tax regulations.