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Dividend Income vs. Ordinary Income

Original post by Cam Merritt of Demand Media

If the only money you have coming in is from a job and maybe interest on a savings account, yours is strictly "ordinary" income. That's not a comment about you or your job; it's just what what the tax code calls income from such sources. If you own stock in corporations, you're probably also getting dividend income, and dividend income may or may not be ordinary income.

Ordinary Income

The Internal Revenue Code categorizes all income as either ordinary income or capital gains. A capital gain is the profit you make from selling an asset for more than you bought it. If you bought $10,000 worth of stock and sold it for $15,000, for example, you would have a $5,000 capital gain. Or if you bought an office building for $1 million and sold it for $1.3 million, you'd have a $300,000 capital gain. Ordinary income is just about everything else -- from wages, salaries and tips, to interest and self-employment income, to lottery prizes and poker jackpots. To encourage and reward long-term investment, the federal government taxes most capital gains at a lower rate than ordinary income.

Dividend Income

If you own stock in a corporation, that makes you a part-owner of that company. Many companies regularly distribute some of their earnings to their stockholders as dividends. Dividend income, then, is money you receive as a result of owning a share of a corporation. In many cases, but not all, dividend income is also ordinary income.

Types of Dividends

Dividends commonly come in cash. If a company declares a cash dividend of 20 cents a share, and you own 1,000 shares, you get $200. That $200 may be taxable to you either as ordinary income or a capital gain, depending on whether the IRS considers it "qualified." Companies that want to reward their stockholders but don't want to part with a lot of cash might instead pay stock dividends, in which shareholders receive additional shares of stock based on how many shares they already own. Except in rare cases, stock dividends aren't taxable as income. However, if and when you sell the shares you receive, you may have to pay capital gains tax on the proceeds.

Qualified Dividends

Qualified dividends are a special category of dividend that gets taxed at the capital gains rate. The definition of qualified dividends is complicated, running more than 1,200 words in the IRS's basic publication for taxpayers, but it boils down to three criteria: The corporation must be based in the U.S. or in a country with which the U.S. has a tax treaty; you must have held the stock for a specified period of time before the dividend; and the dividend must not be of a type specifically barred from being qualified. As Matt Krantz of "USA Today" writes, you don't really have to know the particulars. Just look at IRS Form 1099-DIV, the document you receive at the end of the year that details how much you received in dividends. Total dividends appear in Box 1a of this form. Qualified dividends appear in Box 1b. Any dividends that aren't qualified are ordinary income, taxed the same as the wages from a job or the interest on a savings account.

                   

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About the Author

Cam Merritt has been a professional writer and editor since 1992, specializing in articles about spectator sports, personal finance and law. He has produced content for "USA Today," "The Des Moines Register" and the "Better Homes and Gardens" family of magazines and websites. Merritt has a Bachelor of Arts in journalism from Drake University.

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