One of the current benefits dividend investors can receive right now is the ability to receive favorable tax treatment on qualified dividends. Until the end of 2012 (unless Congress makes changes), it is possible to have certain dividends taxed at the long-term capital gains rate.
The current long term capital gains rate (again, extended through 2012) caps at 15%. For those in the lowest tax brackets, there is no tax at all on long term capital gains. Short term capital gains, though, are taxed at your regular income rate. Non-qualified dividends are also taxed at this rate. This means that, if you are in the 28% tax bracket, your non-qualified dividends will be taxed as ordinary income. With the proper planning, though, you can ensure that most of your dividends are qualified – paying no more than 15% on your dividend income, no matter your income bracket.
Making Sure Your Purchases are Qualified
If you want to be able to claim your dividends as qualified, you need to own the stock or mutual fund in question for more than 60 days in the 121 days preceding the 60 days before the ex-dividend date. This means that you need to think carefully about when you buy shares if you want the tax favored status that comes with qualified dividends.
Before you purchase a share of a company or a mutual fund, find out when the dividend will be paid out. With a company, you can use the ex-dividend date as your guide, or you can simply make your purchase after the dividend has been distributed.
The same is true of buying mutual fund shares. Look at the fund’s distribution schedule and find out when dividends and capitals gains are normally distributed. Make your purchase just after a distribution takes place. This way, you will be able to ensure that you meet the definition of “qualified,” and receive the long term capital gains rate as you pay taxes on your income.
Paying Taxes on Reinvested Dividends
It’s important to realize, too, that you will pay taxes on reinvested dividends. Even though you don’t receive the cash in hand, it is still considered income by the IRS. So take this into account when purchasing shares in a new company or mutual fund. Just because you plan to have the dividends automatically reinvested doesn’t mean you are protected from paying taxes. The only way to avoid it right now is if your dividend investments are held in a tax advantaged retirement account.