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TAX RATES FOR DIVIDENDS: WHAT’S AHEAD
By: Julian Block
THE TAX ADVISER
Investors now benefit from super-low tax rates on dividends. President Bush’s tax code revisions included a dramatic drop in the tax rates for dividends for all investors — to less than half the top rate for ordinary income. Previously, the rates for dividends were the same as the rates for wages, pensions and other types of ordinary income. The current rules tax dividends received by shareholders from corporations and mutual funds at a top rate of 15 percent for someone in the four top income brackets and zero percent — down from 5 percent before 2008 — for someone in the two bottom brackets. The revisions did not reduce the rates for interest, which are taxed as ordinary income.
But all dividends are not equal. The current 15 percent or zero percent rates apply only to “qualifying” dividends, while dividends that fail to pass the qualification tests are taxed at ordinary-income rates that go as high as 35 percent.
For example, there are no reduced rates for dividends from stock purchased with borrowed funds when the dividends are included in investment income. Investors may do this to in an effort to increase the amount allowable as an itemized deduction for investment interest expenses on Schedule A of Form 1040. But the 2003 tax act stipulates that a taxpayer’s election to treat such dividends as investment income results in their being taxed at ordinary income rates. This mirrors the pre-2003 act rule mandating that long-term capital gains must be taxed at ordinary-income rates if they are treated as investment income.
Another limitation on reduced rates targets short-term traders and day traders. Investors must own stock for at least 61 days for dividends to qualify. Otherwise, any dividends received are taxed as ordinary income. Moreover, the 61 days must occur during a 121-day holding period that starts 60 days before the stock’s ex-dividend date. Usually, the ex-dividend date is a few days before the “date of record” on which the corporation completes the list of shareholders entitled to receive dividends.
Special rules apply to foreign corporations. Generally, their dividends qualify for reduced rates only if their shares are traded on established United States securities markets, they are subject to tax treaties that satisfy certain requirements, or they are incorporated in United States possessions. No break is allowed on dividends from foreign outfits that are defined as personal holding companies, investment companies or passive investment companies.
Like the reduction of tax rates for ordinary income, the reduction for dividends is not permanent. The rates of 15 percent or zero percent for dividends remain in effect through 2010. Unless the reduction is extended, in 2011 and subsequent years, dividends will again be taxed at ordinary-income rates (which may go as high as 39.6 percent).
During the lengthy presidential campaign, Barack Obama proposed an increase from 15 percent to 20 percent for the top rate for dividends for individuals in the two top income tax brackets — adjusted to affect only individuals with incomes over $200,000 and families with incomes above $250,000. (It is not clear whether the $200,000/$250,000 figure refers to wages, gross income, adjusted gross income or taxable income.) Under that approach, investors in the bottom four income tax brackets would still be taxed at a rate of zero percent on dividends.
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Copyright 2009,
