For the last few years, there have been tax breaks for investors with long-term capital gains, as well as for qualified dividend investors. As part of a tax deal at the end of 2010, favorable tax rates on qualified dividends were extended through 2012, so the same tax rates apply to qualified dividend income as apply to long-term capital gains. Right now, that means that those in the 10% and 15% brackets pay no taxes on such income, and those in higher brackets pay 15%. (Everything could change starting in 2013, depending on what Congress decides to do.)
This situation means that many people have been enjoying tax-free dividend income – as long as it’s qualified. You need to have an understanding of qualified dividends vs. unqualified dividends if you expect to fully take advantage of your tax status:
Information on dividends, and how they are taxed, can be found in IRS Publication 550. “Qualified” status is awarded to dividends that are paid by a U.S. corporation, or a properly qualified foreign corporation. In most cases, the dividends you earn as a result of stock held in most U.S. C corporations are considered qualified dividends. Additionally, you must meet a specific holding period.
In order to be “qualified,” the IRS says that you must own the stock for more 60 days during the 121-day period beginning 60 days prior to the ex-dividend date. As long as you keep things relatively simple, this is fairly easy to figure out. Things start to get a little more difficult when you use option strategies. You might need a tax professional to help you sort things out in more complicated scenarios.
Even if your stock holdings meet the requirements above, there are some dividends that are never treated as “qualified.” You should be aware of these dividends, so that you don’t make the mistake of paying less in taxes than you owe. Here are the items that the IRS says will never be treated the same as “qualified” dividends:
- Capital gains distributions.
- Dividends paid from tax-exempt corporations or famer’s cooperatives.
- Dividends received from deposits with credit unions, building and loan associations and financial institutions that are structured similarly.
- Payments received in lieu of dividends, if you have reason to know that they are not “qualified” dividends.
- Dividends paid on ESOPs maintained by corporations for their employees.
- Dividends from stock shares that require you to make related payments for positions that are in substantially similar or related properties (such as in the case of a short sale).
- Shown dividend payments in box 1b of Form 1099-DIV from a non-qualified foreign corporation.
If you have questions about the status of your dividend payments, it’s a good idea to double check with a tax professional or investment professional. Non-qualified dividends are taxed at your normal tax rate, so if you are in a marginal tax bracket above the 15% level, you will have to pay that tax rate.