Reply To: Qualified Dividends impact on Ordinary Income Tax Bracket

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#74271
Kaye Thomas
Moderator

Here’s how it works. Both qualified dividends and long-term capital gain are included in adjusted gross income (line 11 of Form 1040) and taxable income (line 15). But when you have these items, your tax is figured by dividing your income into two categories. One part is taxed at rates for what we call ordinary income, and the other part is taxed at the special rates that apply to these dividends and capital gains. (This happens in either the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet.) Because the dividends and capital gains are subtracted from total taxable income before applying the rates for ordinary income, those items don’t push the ordinary income into a higher bracket.

For example, suppose you have $80,000 of pension income and $400,000 of qualified dividend income. The amount of tax you’ll pay on the $80,000 of pension income will be the same as if you had zero dividend income. Tax on the dividend income is extra, but doesn’t change what you pay on the pension income.

This is a bit of a simplification, because I’m ignoring the possibility of indirect effects. The dividend income could cause you to lose some other tax benefit, making a greater amount of the pension income taxable. The fact remains that the qualified dividend income itself doesn’t throw you into a higher tax bracket.