Qualified Dividends

Posted on November 17, 2008 
Filed Under Capital Gains and Losses, Federal Income Tax

Qualified Dividend Income
The value of a dividend paid by a domestic corporation or a qualified foreign corporation to a taxpayer between January 1, 2003 and December 31, 2010 will be recognized by the Internal Revenue Service as qualified dividend income thereby making it eligible for a lower ; this is the reason such income is labeled qualified dividend income. Qualified dividend income is taxed in 2007 at a 5% rate for taxpayers in the 10% and 15% tax brackets and at a 15% rate for those in the 25%, 28%, 33%, and 35% . In 2008 through 2010, a 0% rate will apply to taxpayers in the 10% and 15% tax brackets; the rates for taxpayers in the 25%, 28%, 33%, and 35% tax brackets will remain at 2007 levels.

A domestic corporation is a corporation created or organized in the U.S. A qualified foreign corporation is a non-domestic corporation other than a passive foreign investment company that is domiciled in a U.S. possession or territory or eligible for the benefits, including an exchange of information program, of a comprehensive income tax treaty with the U.S. A dividend from a foreign corporation is also a qualified dividend if it is paid on stock or an anti-deferral regime (ADR), and the stock or ADR is traded on an established U.S. securities exchange.

Ordinary Dividend Income
In contrast, the value of a dividend paid by a nonqualified corporation–that is, any corporation not a domestic corporation or a qualified foreign corporation–is classified as ordinary dividend income and taxed at ordinary income rates. Dividend income is defined broadly as the value of any distribution of money or property to a shareholder that is paid out of a corporation’s current earnings and profits or those accumulated after February 28, 1913. If a dividend is paid in cash, the amount of dividend income is obviously the amount of cash distributed to a shareholder. Likewise, the amount of dividend income for a distribution of property–a dividend paid in a form other than cash–is the property’s fair market value. In the process of calculating taxable income from a dividend distribution, the category of property includes all stock–but not a stock dividend from the distributing corporation unless it is of a class different than that on which the dividend is declared–and any economic benefit, regardless of form, a corporation provides to a shareholder, including payments to reduce a shareholder’s debt.

Holding Period Requirements for Dividends Paid on Qualified Stock
The fact that dividends are paid by a domestic or a qualified foreign corporation is a necessary, but not sufficient, condition for favorable tax treatment; for dividends to count as , the taxpayer must also pass the tests–or avoid the traps–listed below.

  1. The common stock of a domestic or a qualified foreign corporation is held for at least 61 days in a 121-day period beginning 60 days before the stock’s ex-dividend date. The holding period requirement is cumulative, that is, the 61-day period doesn’t have to be consecutive. (Note: A stock goes ex-dividend on the first day after a dividend is declared; in the period of time a stock is ex-dividend, the dividend is paid to the seller, not the buyer, of the stock.) Importantly, a taxpayer doesn’t receive credit towards the minimum 61-day holding period for common stock any day her risk of loss is diminished. Specifically, the risk of loss in connection with the qualified stock a taxpayer holds is diminished any day she has, or is bound by, a call option, a put option, or an open short sale contract (viz., a short sale made but not closed) for substantially identical stock or securities. In addition, risk of loss is diminished not only if the taxpayer is a writer of a call or put option for essentially identical stock or securities but also on any day she holds a position in substantially similar or related property. (Note: In figuring the number of days in a stock’s , count the day of disposal but not the day of acquisition.)
  2. The preferred stock of a domestic or a qualified foreign corporation is held for at least 91 days in a 181-day period beginning 90 days before the stock’s ex-dividend date and the dividend is attributable to a period of more than 366 days. As with common stock, the holding period doesn’t have to be consecutive nor does the taxpayer receive credit towards the minimum 91-day holding period for preferred stock any day her risk of loss is diminished.
  3. Any portion of a dividend that is treated as investment income in order to justify a investment interest deduction is not a qualified dividend.
  4. Dividends from a tax-exempt organization or a farmers cooperative are not eligible for qualified dividend income treatment.
  5. Any payments in lieu of dividends made by the taxpayer, as a short-seller, to compensate the lender of the otherwise qualified stock in a short sale transaction do not count as qualified dividends.

A dividend paid to a taxpayer by means of a pass-through entity such as a mutual fund or other regulated investment company, real estate investment trust, partnership, or a common trust fund is also eligible for the favorable capital gains rate if the distribution would otherwise be classified as qualified dividend income.

The reduced capital gains tax rate a taxpayer enjoys for qualified dividend income does not apply to dividend distributions from tax-deferred retirement vehicles such as deferred annuities, individual retirement accounts, 401(k) plans, and employer stock held on the date of record in an employee stock ownership plan that is maintained by the employer corporation. Moreover, the value of a dividend received from a building and loan association, credit union, mutual insurance company, mutual savings bank, or a nonprofit voluntary employee benefit association is not considered qualified dividend income and will be taxed at ordinary income rates.

Supplementary relevant articles on qualified dividends are listed below:

Many happy returns, Roger

Comments

Leave a Reply

You must be logged in to post a comment.