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> Information provided on this site is for general guidance only and is often simplified. Actual IRS procedures are complex, and taxpayers should obtain professional assistance or use IRS sources for complete information.

Last updated: 24th October 2012

Taxation Of Dividends
Most 'ordinary' dividends are known as 'qualifying' dividends and are taxed special low rates of 5% or 15%.

Taxation Of Capital Gains
Gains made on the sale of property (widely defined) are taxable as capital gains; gains made in the course of trading are more likely to be taxable as business income.

Taxation Of Dividends

For an individual, dividends are distributions of money, stock, or other property paid by a corporation. Dividends may also be received through a partnership, an estate, a trust, or an association that is taxed as a corporation. Dividends and other distributions received as a beneficiary of an estate or trust are generally taxable income. In certain circumstances, part of a child's investment income may be taxable in the hands of the parent(s).

Dividends re-invested in stock without being paid out as such still count as taxable dividends. Income paid out from money market funds counts as dividend income.

The payer of a corporate dividend normally provides Form 1099-DIV, which details distributions during the year. It does not have to be attached to a tax return. The payer of a distribution from a partnership or subchapter S corporation should provide Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S).

Dividend income is not subject to regular withholding, although occasionally it may have been taxed under what is termed 'backup' withholding. The payer should normally provide a Form 1099-DIV showing the amount withheld.

Most dividends are paid out of the earnings and profits of a corporation and count as regular income; they are known as 'ordinary' (ie taxable) dividends. Ordinary dividends are shown in box 1a of Form 1099-DIV.

Under tax-cutting legislation passed in 2003, and extended by The Tax Increase Prevention and Reconciliation Act of 2005 until 2009 (and extended through to the end of 2012), most 'ordinary' dividends are known as 'qualifying' dividends and are taxed at special low rates of 5% or 15%*. Qualified dividends are shown in box 1b of Form 1099-DIV.

(*In tax years beginning after 2007, the 5% maximum tax rate on qualified dividends and net capital gain was reduced to 0%. Thus, qualified dividends and net capital gain are not taxed if the regular tax rate that would apply to them is lower than 25%.)

To qualify for the low rates, all of the following requirements must be met:

  • The dividends must have been paid by a US corporation or a qualified foreign corporation (one which is incorporated in a US possession, one which is eligible for the benefits of a comprehensive income tax treaty with the United States that the Treasury Department determines is satisfactory for this purpose and that includes an exchange of information program (there are 57 such treaties), or one whose shares are readily tradable on an established securities market in the United States. A corporation is not a qualified foreign corporation if it is a passive foreign investment company during its tax year in which the dividends are paid or during its previous tax year.
  • The dividends are not capital gain distributions, dividends paid on deposits with financial institutions (which count as interest), dividends from a corporation that is a tax-exempt organization or farmer's cooperative, or dividends paid by a corporation on employer securities which are held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation. There are some other exceptions as well.
  • The stock must have been held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date (ie the first date following the declaration of a dividend on which the buyer of a stock will not receive the next dividend payment). In the case of preferred stock, the stock must have been held for more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days.

A claim for deduction of investment interest may reduce the amount of qualified dividends that are eligible for the 5% or 15% tax rate. The shareholder must reduce the qualified dividends eligible for the lower rates by the amount of qualified dividends the shareholder chooses to include in investment income when figuring the limit on the investment interest deduction.

A US citizen with dividend income from sources outside the United States must report that income unless it is exempt under US law.

A non-dividend distribution is one that is paid out of the capital assets of a corporation and reduces the basis value of a stock-holding, rather than as a dividend. It can be thought of as a return of capital. Only when the capital value of stock has been completely repaid does a non-dividend distribution become taxable, and then it is as a capital gain. Some types of 'rights' issue can be classified as taxable dividends - the rules are complex.

Exempt-interest dividends paid by a regulated investment company (mutual fund) are not taxable, but must be reported. Exempt-interest dividends paid from certain types of bond may be subject to the alternative minimum tax.

In November 2006, it emerged that the IRS had ended uncertainty by adding Barbados to the list of countries eligible for reduced tax rates on dividends paid by foreign corporations under the 2003 Jobs and Growth Tax Relief Reconciliation Act.

The IRS confirmed that Barbados is a "satisfactory" jurisdiction, able to enjoy the benefit of reduced withholding rates of 15% on dividends paid to individual shareholders from either a domestic corporation or a qualified foreign corporation.

Although dated October 30, 2006, the IRS Notice indicated that with respect to Barbados, the effective date for the accrual of this benefit was as of December 20, 2004.

The Barbadian government said that the important reclassification had come about as a direct result of the successful conclusion of a Second Protocol to the 1984 Barbados-US treaty. This Protocol was signed in July 2004 and entered into force shortly thereafter, on December 20, 2004.


Taxation Of Dividends
Most 'ordinary' dividends are known as 'qualifying' dividends and are taxed special low rates of 5% or 15%.

Taxation Of Capital Gains
Gains made on the sale of property (widely defined) are taxable as capital gains; gains made in the course of trading are more likely to be taxable as business income.

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