Q:

How are dividends taxed?

A:

Quick Answer

Dividends are taxed in two ways, either as ordinary income or as capital gains. If taxed as ordinary income, the amount of tax due is based on the tax bracket of the recipient. If taxed as a capital gain, then the capital gains tax rate applies.

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Full Answer

Dividends are the result of buying certain stocks or mutual funds. They represent a share of the profits from the companies in which one has invested. The larger the share, the larger the dividends. To receive the preferred capital gains tax rate on a dividend, the dividend must meet certain standards.

The standards for the preferred capital gains tax rate on common stock are that the stock must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. If the dividend is for preferred stock, though, the holding period is extended to 90 days during the 181-day period that begins 90 days before the ex-dividend date. In the case of preferred stock, the dividends must also represent earnings over a period of more than 366 days.

The preferred capital gains tax rate is lower than the ordinary tax rate for dividends. The preferred tax rate is based on the size of the dividends received, and runs from 0 to 20 percent, as of 2014.

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