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About Qualified Dividends

Qualified Dividends Definition  
A qualified dividend is an ordinary dividend that meets certain criteria and thus becomes eligible for reduced taxation or capital gains tax rates.

A dividend is a distribution (cash, stock, or other property) from a corporation or a mutual fund paid to the shareholder of that corporation or mutual fund. Ordinary dividends are taxed at an individual's ordinary income rates. However, since 2003, certain dividends have been denoted as ‘Qualified’ and subject to a lower tax rate (0% or 15%). Effective January 1, 2013, qualified dividend tax rates are 0%, 15%, or 20%. Some investors who are subject to the 15% or 20% tax rates are also subject to the additional Net Investment Income Tax (NIIT) rate of 3.8%, which became effective January 1, 2013.

To qualify for the lower capital gains tax rates, all of the following requirements must be met:

    (1) The dividends must have been paid by a U.S. corporation or a qualified foreign

    (2) The dividends are not of the type listed under Dividends that are not qualified

    (3) You meet the holding period.

When determining a taxpayer’s dividend income, it is important to understand the interaction between dividends and other taxable events, namely constructive sales and straddles.

Holding period
I.R.C. § 1(h)(11) defines when dividends are qualified for preferential tax treatment (0%, 15% or 20% rate). There is a holding period requirement to be eligible for the lower tax rate. Per Pub 550, a taxpayer “must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.”

Days not counted toward the holding-period requirement include those where “a taxpayer has diminished his risk of loss.” To determine whether or not the holding period has been met, factors that reset the holding period and those that suspend the holding period must be considered. Straddles and Constructive Sales both affect how holding period days are counted.

We have several resources you can consult for more information on all of these topics. Please see our About Straddles and our Constructive Sales sections for information on these taxable events. Our Qualified Dividend Income white paper discusses the interaction of qualified dividends, straddles and constructive sales in more detail. For a discussion on determining when risk of loss is diminished, please see our white paper, Using Market Risk Concepts to Refactor Tax Shelters.

Exception for preferred stock
A special case is made for preferred securities. Once preferred securities are identified, the calculation process is similar to that of common stock but includes a few rule changes. For these securities, when the dividend covers a period greater than 366 days, the holding-period window changes. The period is increased to more than 90 days, and a 181-day window is used to bracket the calendar.

Tax Analysis of Securities Transactions (TAST)  
Activity: The fund buys 1,000 shares of company ABC stock. The original purchase date (tax lot date) is 6/1/2011. ABC issued a $0.05 dividend with an ex-date of 6/20/2011. The stock is later sold on 8/25/2011.

Result: The qualification period is: 6/20/2011 – 60 days = 4/21/2011 through 4/21/2011 + 121 days = 8/20/2011. The stock must be held for more than 60 of the days between 4/21/2011 and 8/20/2011. We see that the stock is held from 6/1/2011 through 8/25/2011 and constitutes 85 days, 80 of which fall inside the 121-day window; since 80 is greater than 60, the dividend is qualified.

For a more in-depth discussion on Qualified Dividends, please read our Qualified Dividend Income white paper. Complete with examples, this paper discusses the interaction of constructive sales and straddles on dividends and how to determine whether or not a dividend qualifies for a lower tax rate.

You can read other white papers we have published that address issues related to Tax Analyses of Securities Transactions (TAST) in our White Papers Section.

On May 28, 2003, President George W. Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). This law reduced the tax rate for dividends produced by securities that have been held as long-term investments. Traditionally, dividends were taxed as ordinary income for investors and therefore this income was taxed at the highest possible rate. As a result, many investors would encourage companies NOT to pay dividends but rather use the cash for mergers and acquisitions or other activity that is exempt from taxation and which would still add value for the shareholder. In order to ‘unlock’ this cash for distribution to shareholders, this provision of the JGTRRA was included to encourage companies to behave more ‘normally.’

Here’s what’s in the tax code  
The holding period for qualified dividends is reduced when risk of loss is diminished. “When determining whether you met the minimum holding period discussed earlier, you cannot count any day during which you meet any of the following conditions.

    (A) You had an option to sell, were under a contractual obligation to sell, or had made
          (and not closed) a short sale of substantially identical stock or securities.

    (B) You were grantor (writer) of an option to buy substantially identical stock or

    (C) Your risk of loss is diminished by holding one or more other positions in
          substantially similar or related property. “

IRS Resources  
Click here to access Pub 550, the IRS publication that provides information and guidance on complying with sections of the Internal Revenue Code (IRC) that pertain to investment income and expenses.

To read specifically about Qualified Dividends as described in Pub 550, click here.

Relevant webinars  
Tax Analysis of Dividends

Relevant video clip  
Qualified Dividends

Relevant white papers  
Qualified Dividend Income
Constructive Sales
Tax Implications of Straddles
Using Market Risk Concepts to Refactor Tax Shelters