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An advantageous way to retire is to live on dividends. This would mean that you have invested your money so wisely over the course of your working life that you get paid for the labor of others because that’s what dividends are – the profits of a company that are paid to shareholders. Sounds sort of lazy, right? Well maybe, but America rewards working not only hard, but smart. Anyway, I digress. The purpose of this article is to fill in the common gaps in people’s knowledge on dividends. Furthermore, this article will also go into other distributions that, while not dividends, are reported on the same information return.

For the purposes of this post, there are two types of dividends, ordinary dividends, which are taxed at normal income tax rates, and qualified dividends, which are taxed at capital gain tax rates. What’s more, qualified dividends are a subset of ordinary dividends, so if you want to think of a Venn diagram, qualified dividends would be a circle entirely within the larger circle of ordinary dividends. Ordinary dividends are shown in box 1a of Form 1099-DIV, while qualified dividends are shown in box 1b.

You may be asking, but what are qualified dividends? The answer is: ordinary dividends that meet certain arbitrarily set government requirements, which are as follows: 1) the dividends must be paid by a U.S. corporation or qualified foreign corporation; 2) the dividends are not specifically excluded as non-qualified dividends; 3) you meet a holding period of at least 60 days during the 121 day period, beginning 60 days before the ex-dividend date, or the date on which it’s announced that the seller of the shares receives the dividend and not the buyer. There is a differing rule for preferred shares, which is 90 days during the 181 days of the ex-dividend date. If this doesn’t make a whole lot of sense, don’t worry. It’s not worth being concerned about.

Referring back to point two above, the following dividends are not qualified: 1) capital gain distributions; 2) dividends on deposits; 3) dividends from a non-profit or farm cooperative; 4) dividends paid through certain employee stock ownership plans; 5) dividends from short sale shares held; 5) payments in lieu of dividends that are, in fact, known not to be dividends; 6) dividends shown in box 1b from a foreign corporation that are known not to be qualified. Again, this seems somewhat esoteric, but it’s good to know. By the way, this is probably the reason that most people knowledgeable on dividends don’t go into a detailed explanation of what qualified dividends are, because they are largely defined by a list of hard-to-understand winding requirements, replete with jargon.

Additionally, if you’ve thought that you can get around paying taxes on your dividends by just reinvesting those dividends into more shares of the same company, like in a dividend reinvestment plan, then you thought wrong. Even if you reinvest your dividends into purchasing more shares of the same company you must pay taxes on the dividends, regardless of whether those dividends ever hit your bank account.

Another thing you may have noticed on your Form 1099-DIV is capital gain distributions, which are shown in box 2a. These are distributions that are paid by mutual funds or real estate investment trusts (REITs). Essentially, capital gain distributions are a portion of these investments’ proceeds from the sale of shares that are then distributed to the shareholders. Capital gain distributions are given favorable tax treatment as they are reported as long term capital gains on Schedule D, line 13, regardless of the amount of time the shareholder has held the subject shares.     

Next, a nondividend distribution is an amount that isn’t paid out of earnings or profits, and also is not a capital gain distribution. It’s instead treated as a return of capital, meaning that it is essentially a return of the initial amount invested, so in this regard it is not taxable. However, it does have a tax consequence in that it reduces the basis in the investment in the amount of the nondividend distribution. As a result, when the basis in the investment is reduced to zero, any additional nondividend distributions are taxable as long term capital gains, reported on Schedule D, Part II.

What’s more, boxes 9 and 10 on Form 1099-DIV represent cash and noncash liquidation distributions, which come about when a corporation is liquidated and thereafter ceases to exist. As a result of the nature of the initial investment, a part of this liquidation payment is a return of capital or a return of the amount initially invested and therefore non-taxable, and depending on the amount received upon liquidation and the length of time you held the shares, you report any gain as a short or long term capital gain on Schedule D.

You report dividends found on Form 1099-DIV in one of two places, or both. Specifically, if you have over $1,500 in ordinary dividends, report your dividends on Schedule B, Part II. Furthermore, if any of your dividends are qualified, report their aggregate on line 3a of Form 1040, and the total of your ordinary dividends from Schedule B on line 3b, also on Form 1040.

For more information on dividends see IRS Publication 17.

If you are having issues with dividends or have any other tax problem, don’t be shy, call Dino Tax Co today at (713) 397-4678, or email us at davie@dinotaxco.com. We are here to help you! Your initial phone consultation with us is always free. Also, like us on Facebook at www.facebook.com/dinotaxco.