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How Are Dividends and Other Corporate Distributions Taxed? 
 
by kmhagen July 07, 2005

Qualified Dividends

Qualified dividends are ordinary dividends that are subject to the 5% or 15% maximum tax rates that apply to net capital gains.  These dividends are reported in box 1b of Form 1099-DIV.

In order to be considered a qualified dividend, the following tests must be met:

  1. The dividends must have been paid by a U.S. corporation or a qualified foreign corporation (including foreign personal holding companies and foreign investment companies).  A qualified foreign corporation must be incorporated in a U.S. possession, must be eligible for the benefits of a comprehensive income tax treaty the U.S. has with that country (listed in Publication 550, Investment Income and Expenses, under Tax Treaties), or its stock (including ADRs) must be readily tradable on an established securities exchange in the U.S.
  2. The dividends must not be specifically excluded under dividends that do not qualify (see below).
  3. You must meet the holding period requirement – you must have held the stock for at least 60 days during the 121-day period that begins 60 days before the ex-dividend date.  For preferred stock, the holding period is 90 days during the 181-day period that begins 90 days before the ex-dividend date.  Days on which your risk of loss is reduced do not count toward meeting the holding period requirement.  Your risk of loss is reduced under any of the following conditions:
    1. You had an option to sell, or had made, but not closed, a short sale of substantially identical stock.
    2. You granted an option to buy substantially identical stock.
    3. You hold one or more positions in substantially identical stock to reduce your risk of loss.

Dividends That Do Not Qualify

Dividends that are not treated as qualified dividends for purposes of the 5% or 15% tax rates include:

  • Capital gain distributions.
  • Dividends on deposits with savings and loan associations, or similar financial institutions.  These are taxable as interest income.
  • Dividends from a tax-exempt organization or farmer’s cooperative.
  • Dividends on securities held by an employee stock ownership plan.
  • Dividends on shares for which you are obligated, under a short sale or otherwise, to make payments for positions in substantially similar stock.
  • Payments in lieu of dividends.

Reinvested Dividends

If you reinvest dividends and buy more stock, you will still have to report dividend income.

  • If you reinvest the dividends and buy additional stock at a price equal to its fair market value (market price) on the dividend date, you report the amount of the dividends as income.
  • If you have a dividend reinvestment plan that lets you buy more stock at a price lower than its fair market value, you report the fair market value of the additional stock on the dividend payment date as dividend income.
  • If under the dividend reinvestment plan, you can invest more cash to buy additional shares at less than their fair market value, you report as dividend income the difference between the cash you invest and the fair market value of the stock on the dividend payment date.

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