An important qualifier for a lower tax rate is the type of company paying a dividend. For example, REITs, certain foreign companies, and MLPs don't qualify for lower tax rates. For REITs and MLPs, this is because their corporate structure is such that they pay no federal income tax. Called "pass-through" entities -- so long as they meet certain qualifications -- they don't pay federal income tax, meaning they are able to reward investors with higher yields. The IRS treats those payouts differently and taxes them at a higher rate. U.S. investors should consider holding a REIT and foreign dividend stocks in a retirement account such as an IRA, avoiding most (or even all) of the taxes paid in a taxable account.
Unfortunately, that's sometimes not an option for an MLP because of something called unrelated business taxable income, or UBTI, that can leave investors owing tax on assets in a retirement account. To avoid this potential complication, many brokers don't allow investors to own MLPs in an IRA or a Roth IRA.
Finally, investors in higher tax brackets should be aware of companies that routinely pay special dividends since those are usually nonqualified payments. Because of that, high-wage earners might want to consider holding companies known for special dividends in an IRA instead of their regular brokerage account.
Know the dividend type before making an investment
The tax rate on a nonqualified dividend can be as high as 37%, well above the 20% cap on qualified payments. Investors in higher tax brackets should make sure a stock's dividend will qualify for the lower tax rate before making that investment since it could save them money at tax time. You also need to pay attention to your holding period and whether the company qualifies, which can dictate whether to hold off on making the purchase or buying shares in a tax-advantaged account.
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