Taxes on Qualified Dividends

Updated 01/31/14

Lower Tax Rates

The much of the following discussion is adapted from an original document published by Fidelity Investments. It has been edited for clarity, brevity, and additional content has been added. Consult a tax specialist before filing your taxes. This information is summary in nature, likely out of date, and should not be used to prepare your taxes.

12/31/2003

The economic landscape has changed dramatically since President George W. Bush entered office. Five major tax cut packages have been signed into law, producing over $2.0 trillion of tax relief. The Jobs and Growth Tax Relief Reconciliation Act of 2003 introduced a new category of qualified dividend income taxable at federal rates to 15% (or 5% for taxpayers in the two lowest tax brackets). Qualified dividends are generally distributions from domestic corporations and certain qualified foreign corporations.

The lower tax rates potentially apply to qualified dividends received on or after January 1, 2003, as long as the dividend-generating security was held unhedged for a requisite period . Those ordinary dividends that may qualify to be taxed at one of the lower rates are reported as qualified dividends on Form 1099-DIV. Ordinary dividends that are not reported as qualified may be taxed at your ordinary income tax rate, which can be as high as 35%

Hedged Defined

 In general, if you enter into any sort of risk limiting arrangement through short sale, options, or futures, then your qualified dividend status could be in jeopardy. Consult a tax specialist if your future plans rely on qualified dividends. The securities must be unhedged only during the required holding periods, not the entire tax year.

Requisite Holding Periods for Dividend Paying Stock

For qualified dividends you received, you must have held the securities for at least 61 days out of the 121-day period that began 60 days before the ex-dividend date. For certain preferred stock, the relevant holding period is at least 91 days out of the 181-day period beginning 90 days before the ex-dividend date.

Requisite Holding Periods for Dividend Paying Mutual Funds

For qualified dividends you received from a mutual fund the holding period should be met as long as:

• The shares of the security were held by the fund for at least 61 days out of the 121–day period that began 60 days before the security's ex-dividend date, and
• The amounts received by the fund were subsequently distributed to you, and
• You held the shares of the fund for at least 61 days out of the 121–day period that began 60 days before the fund's ex-dividend date.

Two-Step Process to Determine Eligibility

If you purchased or sold dividend-paying securities (such as stock or mutual fund shares) during the year, not all the dividends reported in line or column 1b of Form 1099-DIV as Qualified Dividends will be taxable at one of the lower tax rates. Qualified dividends must meet the requisite holding period for the security. Non-qualified dividends are taxed at your ordinary income tax rate.

If you neither bought nor sold securities during the year, the qualified dividends reported on your Form 1099-DIV satisfy the requisite holding period test aand re taxable at one of the lower tax rates (unless you hedged the securities). 

Step 1: Determine How Long You Held Shares, an example

The ex-dividend date for XYZ Fund is May 2, 2006. You purchased 10,000 shares of XYZ Fund on April 28, 2006. You sold 2,000 of those shares on June 16, 2006, but continue to hold (unhedged at all times) the remaining 8,000 shares.

• You held 2,000 shares for 49 days (from April 29, 2006 through June 16, 2006) of the required 121-day period and 8,000 shares for at least 61 days (from April 29, 2006 through July 1, 2006) of the 121-day period. When counting the number of days the fund was held, include the day the fund was disposed of, but not the day it was acquired.
• The dividend income from the 2,000 shares held 49 days are not qualified dividend income.
• The dividend income from the 8,000 shares held at least 61 days are qualified dividend income.

Step 2: Determine the Amount of Qualified Dividends Taxed at Lower Rate

Assume for XYZ Fund that a dividend of $0.18 per share was paid but that only 50% of that dividend ($0.09 per share) was ultimately reported as a Qualified Dividend. Since you only held 8,000 out of your total 10,000 shares for the requisite holding period, the calculation to determine the amount of eligible qualified dividends you received would be as follows:

Of the $1,800 reported as Ordinary Dividends for XYZ Fund in line or column 1a of Form 1099-DIV, only $900 would be reported in line or column 1b as a Qualified Dividend. Of that $900, only $720 should be taxable at one of the more favorable rates. The remaining $1,080 of dividends reported should be taxed at your ordinary income tax rate.

Your fund company should provide ex-dividend dates and the amount of the qualified dividend per share for each distribution. If you held an investment that distributed Qualified Dividends for less than the required period, you should contact the specific individual stock or mutual fund company for the ex-dividend dates and the amount of qualified dividend per share for each distribution to complete this calculation for shares of individual securities

Holding Stocks and Fund in Margin Accounts

If you hold stocks and funds in a margin account, it is possible that instead of qualified dividends, it is possible that you will received fully taxable "payments in lieu of dividends". These are payments made when your stock or fund has been borrowed by the broker typically for a short- sale by another investors. You could get stuck with higher taxes. Some brokers will reimburse such higher taxes, but you may have to make application for reimbursement and the reimbursement itself  is a taxable event. You can prevent this problem by moving securities from your margin account  into your cash account where they are ineligible for borrowing.

The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Investors FastTrack does not provide legal or tax advice. Investors FastTrack cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Investors FastTrack disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.