How to Make Sure Taxes Do the Least Amount of Harm to Your Gains

Tax efficiency is especially important for preferred stock investors.

Mar 23, 2014 at 1:00PM


As April 15 approaches, many investors are realizing that a lot of their gains have a date with the IRS. When it comes to personal finance, tax efficiency is important to keeping as much of your gains as possible. For income investors, knowing certain tax rules can make tax time a lot less painful and allow you to keep more of what you gained.

Interest vs dividends
Regarding total income amounts, there is a lot in common between interest payments and dividend payments. But for the purposes of taxes, they are treated very differently. Interest income is taxed at your ordinary income tax rate while qualified dividend income is taxed at a (usually) lower tax rate.

For investors looking at preferred stocks, the difference here can be critical. Often mixed in with preferred stocks are exchange traded debt securities, which pay interest instead of dividends.

Take these insurance examples for instance. Aegon 8.00% Non-cumulative subordinated notes (NYSE:AEK) show up alongside preferred stocks in many screeners. But this issue is made up of debt securities that pay interest, not dividends, and therefore have the payments taxed at the ordinary income tax rate.

A more tax efficient alternative for higher income earners would be MetLife Series B preferred stock (NYSE:MET-B). Since it's actual preferred stock and not exchange traded debt, this series pays income investors with dividends, not interest, making the payments eligible for the qualified dividend tax rate if all other requirements are also met (more on this later).

REIT preferred stock tax alert
Not all preferred stocks are eligible for the qualified dividend tax rate however. Dividends from REIT preferred stocks do not get the same tax benefits as dividends from most other companies.

One example can be found in NorthStar Realty Finance Corp Series A preferred stock (NYSE:NRF). Although this is a type of preferred stock, it is not eligible for the qualified dividend tax rate. When making income investment decisions, it is important to take this into account.

Qualified dividend tax rate
Getting the qualified dividend tax rate requires more than just picking the right investments. The IRS is very clear on what other requirements are needed to obtain a lower tax rate.

Among them are holding period requirements (at least 60 days prior for common stock and at least 90 days prior for preferred stock) and that the dividends must be paid by either a U.S. corporation or a qualifying foreign corporation. For more details and examples of holding period situations and which corporations qualify, the IRS section on qualified dividends actually does a pretty good job explaining it.

Tax time
Creating a tax efficient portfolio is essential to being able to keep the most of your gains as possible. By reviewing the differences between interest paying securities and dividend paying securities, you can better adjust your portfolio for maximum gains.

Of course each situation is unique and you should always run the numbers to see which income investment is really best for you. After all, taxes are just one part of the equation when it comes to investing.

Getting the most bang for your buck
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it’s true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor’s portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

Alexander MacLennan has no position in any stocks mentioned. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. He is not a tax professional and you should always talk to a licensed tax professional before making investment decisions. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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