Here's the tax-time puzzle facing investors who pocketed Microsoft's special $3-a-share dividend late last year: Do you qualify for the...
Here’s the tax-time puzzle facing investors who pocketed Microsoft’s special $3-a-share dividend late last year: Do you qualify for the lower tax rate on dividends?
Maybe. Maybe not.
Uncertainty has existed since President Bush successfully pushed to cut the tax rate on some dividends — but not all — to 15 percent for most investors.
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Investors have good reason to bone up on the rules. U.S. companies paid a record sum of dividends in 2004, with Microsoft alone mailing out checks for nearly $33 billion. All told, nearly 1,300 public companies raised dividends last year. That doesn’t mean you’ll get a break just because you’re staring at a stack of year-end 1099-DIV statements. Here are two reasons you won’t:
They’re the wrong breed:
The lower tax is based on the notion that corporations paid taxes on their profits before they cut dividend checks to shareholders. Dividends that haven’t been taxed at the corporate level generally don’t make the cut.
Dividends from money-market funds and bond mutual funds don’t qualify because they’re really a form of interest payment. Ditto for most preferred stocks, which are debt offerings that pay interest, not dividends.
Real-estate investment trusts, or REITs, generally lose out because they pass along earnings untaxed. And some foreign stocks are excluded if they aren’t traded on certain exchanges or are based in places like Hong Kong that don’t have a tax treaty with the United States.
If that makes your head hurt, down an Advil before continuing.
You didn’t hold the stock long enough:
Before the tax cut, it didn’t matter how long you held a dividend-paying stock. Now it’s critical, because the savings are denied to short-term investors who just want to grab the dividends and run.
Alas, investors must tangle with a timing window straddling the “ex-dividend date,” the first day you can buy the stock and not pocket the dividend. The rules were so baffling that Congress miscounted the days and had to fix an error. Here’s how it now works: To qualify for the lower tax rate, you must hold your stock or mutual-fund shares for at least 61 days during the 121-day period that begins 60 days before the ex-dividend date.
In other words, you can’t buy the stock just before the dividend cutoff, pocket the cash and sell the stock immediately.
Warning: Advil’s manufacturer cautions consumers not to gulp more than six tablets within 24 hours, even during a 121-day period straddling April 15.