Identification

• The IRS defines ordinary dividends as the taxable dividends paid by a corporation to its shareholders. The dividends come from the net earnings of the corporation as a distribution of those earnings to shareholders. Dividends received from shares of common and preferred stock are considered ordinary dividends. Qualified dividends are ordinary dividends that qualify for a lower income tax rate.
  
  

Significance

• Qualified dividends are taxed at a lower rate than the investor's regular income tax rate. Qualified dividends are taxed at either a 0 or 15 percent rate. Qualified dividends are paid by regular U.S. corporations and qualified foreign corporations. Ordinary and qualified dividends are listed as different boxes on IRS Form 1099 DIV sent out to shareholders. The total of ordinary dividends includes the qualified dividends. For example, if the 1099 DIV shows $500 in ordinary dividends and $400 in qualified dividends, the shareholder received $100 in non-qualified ordinary dividends.
  
  

Considerations

• Mutual fund shares pay dividends that may or may not be ordinary and qualified. Mutual fund dividends are the income earned by the securities in the fund passed through to the fund's investors. If the fund receives ordinary and qualified dividends from investments, these will be passed through to investors as ordinary and qualified dividends. A bond fund earns interest from bonds; and when this interest is passed through to bond fund shareholders, the dividends are non-qualified. Form 1099 DIV breaks down the type of dividends paid by the fund.
  
  

Time Frame

• Investors must own the shares of stock or mutual funds for at least 60 days during the period between 60 days before and after the dividend is paid for the dividend to be qualified for the lower tax rate. Investors who buy a stock and hold it for just a few days to collect the dividend will not be able to claim the dividends, as qualified, even though the corporation pays qualified dividends.
  
  

Warning

• The IRS tax law that created qualified dividends and the lower tax rates on qualified dividends expires at the end of 2010. Starting in 2011, all dividends earned will be taxed at a shareholder's regular tax rate.