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The New, Lower Tax on Dividends

http://www.fool.com/personal-finance/taxes/2003/06/20/the-new-lower-tax-on-dividends.aspx

Roy Lewis
June 20, 2003

One of the provisions of the recently passed Jobs and Growth Tax Relief Reconciliation Act of 2003 included changes in how dividends are taxed. Investors will now pay lower tax rates on dividends received from domestic corporations and qualified foreign corporations.

In the past, dividend income was just another source of ordinary income, taxed at your normal tax rate, which could be as much as 35%. No longer. Beginning in 2003 the maximum tax rate on qualifying dividends has been dropped to 15% for most people. And for those of you in the 15% or 10% bracket, qualifying dividends will be subject to a maximum tax of only 5%.

Seems simple, right? Well, it's not as simple as you might think.

Holding period
In order to qualify for the new lower taxes on dividends, you're required to hold the stock on which the dividends are paid for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the last date on which a shareholder of record is entitled to receive the upcoming dividend.

So if you're thinking about "trading" dividend-paying shares in an attempt to simply secure a dividend and have that dividend taxed at a lower rate, don't bother. The holding period rules will simply render your dividends as nothing more than regular income taxed at your normal tax rate.

Will the company tell you if your dividends are qualified? Nope. It'll be your responsibility to determine if any (or all) of the dividends received will qualify for the lower tax rate. This will mean even more record keeping on your part, so be forewarned.

Qualifying dividend income
In order to receive the lower tax rate, the dividends must be received from a domestic corporation or a qualified foreign corporation. A qualified foreign corporation is one that is incorporated in a U.S. possession or is incorporated in a country that has a current tax treaty with the U.S. and meets various other qualifications.

So if you're invested in a foreign corporation that pays dividends, make sure that this corporation will be treated as a qualifying foreign corporation. Take the matter up with the shareholder relations folks at the corporation. They would certainly know if they'd be treated as a qualified foreign corporation.

Not all dividends are created equal
Just because a check is accompanied by a document with the word "dividend" doesn't mean that the money qualifies for the lower dividend tax rate. For example, dividends credited to policyholders by insurance companies aren't qualifying dividends. Neither