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Dividend Tax Considerations

What You Need to Know

by Harry Domash

For Federal income tax purposes, depending on the type of stock, the dividends you receive could be classified as "qualified" or "non-qualified." Which classification applies could affect the income tax rates that apply to your dividends. 

Qualified Dividends
Qualified dividends must be paid by a corporation that is subject to U.S. corporate income taxes, or by a foreign corporation based in a country that is eligible for benefits under a U.S. tax treaty.
Most dividend stocks, such as those issued by utilities, banks or other financial institutions, or firms that make products or sell services, fall into the qualified category. For those, the your dividend tax rate depends on your ordinary income tax rate, but tops out at the maximum capital gains rate, which is 15%.

Ordinary
Income Tax Rate
Qualified Dividend
Income Tax Rate
10% 0%
15% 0%
25% 15%
28% 15%
33% 15%
35% 15%

If your stocks are held in a taxable account, you report qualified dividends on Line 9b of IRS Form 1040. If your dividends totaled more than $1,500, the IRS requires you to detail the payouts on Schedule B.  Click here for IRS dividend filing instructions. If you're stocks are held in a tax-sheltered account, taxes will not be an issue for qualified dividends.

Non-Qualified Dividends
Dividends paid by tax-exempt corporations or trusts such as Business Development Corporations (BDCs), Master Limited Partnerships (MLPs), Limited Liability Corporations (LLCs), or Real Estate Investment Trusts (REITs) are considered non-qualified, and may be taxed at ordinary rates. You report non-
qualified dividends on Line 9a of IRS Form 1040.

Business Development Corporations
BDC dividends are mostly taxed at ordinary income tax rates, However, after the year-end, a BDC may designate a portion of the prior year's dividends as "return of capital," which may be treated as a capital gain. Return of capital payouts reduce your cost basis and are not taxable until you sell your shares, when they are taxed at the appropriate capital gains rate.

Real Estate Investment Trusts
REIT dividends are mostly taxed at ordinary income tax rates. However, after the year-end, a REIT may designate a portion of its prior year's payouts as "qualified dividends," which qualify for the maximum 15% rate.  On average, roughly 20% of annual payouts fall into this category. A REIT may also classify portions of its prior year payouts as return of capital.

Master Limited Partnerships & Limited Liability Corporations
For income tax purposes, MLPs and LLCs are treated the same. Both require filing IRS Schedule K1 forms, which are more complicated than Form 1040s. If they exceed certain limits, portions of dividends received from MLPs and LLCs could be considered "unrelated income," and be taxable. For details on MLP and LLC tax considerations, click here.

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