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NEW LOWER TAX RATES DO NOT APPLY TO ALL DIVIDENDS

THE SAGA OF THE "QUALIFYING" DIVIDEND

(As of July 2003)

The Jobs and Growth Tax Relief Reconciliation Act of 2003 provided that "qualified" dividends ONLY will be taxed at rates of 5% and 15%, depending on the taxpayer’s income tax bracket. Dividends that are not "qualifying" dividends do not receive the preferential tax rates.

The dividend must be paid by a domestic corporation, although some foreign corporation dividends can qualify.

The dividend has to be paid from a corporation out of its earnings.

All dividends income from investments that the taxpayer owns less than 61 days.

Dividends from life insurance policies.

Only the dividend income from mutual funds that have come from qualified corporations. This excludes interest earned by the mutual funds on bonds and other similar investments, and short-term capital gains from securities trading. But, long-term capital gains from mutual funds will also enjoy the lower tax rates.

The majority all of the dividends received from Real Estate Investment Trusts (REITs). REITs are required to pay out at least 90% of their taxable income in dividends to avoid income taxes on those profits, so they are not "qualified" dividends.

Dividends from foreign corporations, except for foreign corporations that are incorporated in a U.S. possession, or those corporations eligible for a benefits of a U.S. income tax treaty, or those corporations who stock is readily tradable on an established U.S. securities market.

Dividends on stocks loaned out under a margin account agreement.

Dividends from S corporations.

Dividends on preferred stock if the stock is not owned for at least 91 days and the preferred shares are not just disguised loans.

Income from tax-deferred annuities.

Dividends from shares that are subject to a short sale or a put.

Dividends from farmers’ cooperatives.

Dividends from mutual savings banks.

A couple of other issues in the tax law changes:

Dividend income cannot be used to offset or absorb capital losses. Dividends are still income and only capital gains can be used to offset capital losses.

If you choose to use dividend income to offset investment interest expense, such as a margin loan, you must give up the special rates on those dividends.

The IRS position as to dividends is:

The recipient of a Form 1099-DIV may treat the amounts reported in Box 1b as qualified dividends, unless he knows or has reason to know that the amounts are not qualified dividends.  In addition, a recipient of a Form 1099-DIV may treat a dividend excluded from Box 1b as a qualified dividend if such person believes the dividend is a qualified dividend, subject to applicable penalties in the event the amount is not in fact a qualified dividend.

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