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, most 'ordinary' dividends
are known as 'qualifying' dividends and are taxed
special low rates of 5% or 15%. Qualified dividends
are shown in box 1b of Form 1099-DIV.
Qualified dividends are subject at the time of
writing to the 15% rate if the regular tax rate
that would apply is 25% or higher. If the regular
tax rate that would apply is lower than 25%, qualified
dividends are subject to the 5% rate. 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 cooperativ, 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.
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