Jeff Reeves for USA Today writes: One of the most powerful ways to invest in the stock market is
to buy high-yield dividend stocks and hold them for the long term. These
investments provide regular cash distributions that can really add up
over time.
Take Coca-Cola (NYSE:KO), a favorite among
dividend-stock investors. If you invested $10,000 in Coke 20 years ago,
you'd be sitting on roughly $10,000 in dividends alone – not to mention
the nice share appreciation as Coke's stock price has quadrupled!
Some
investors simply like the additional profits of dividends, while others
see their quarterly payments as "paychecks" that are a reliable income
stream in retirement. But whatever your mindset is, it's crucial to get
the tax forms right. There are a host of investments that deliver
regular payments to investors, but not all of them play by the same
rules.
Here are five tips to make sure your dividend taxes are filed correctly:
Trading around a dividend date can hurt you:
"Qualified dividends" are taxed at long-term capital gains rates, but
"unqualified dividends" are taxed as ordinary income, at a higher rate.
To ensure your dividends are qualified, you must have "held the stock
for more than 60 days during the 121-day period that begins 60 days
before the ex-dividend date," according to the Internal Revenue Service.
If that language confusing check out this case study on IRS.gov, but the bottom line is that buying or selling a stock close to a dividend date could mean a higher tax rate.
Some investments are "unqualified" payers:
Some very common investments do not pay qualified dividends, and are
subject to higher taxes regardless of the holding period. The tax code
says qualified dividends come from "domestic corporations and qualified
foreign corporations." In other words, if your underlying investment
isn't a set up as a corporation or is domiciled overseas, there's a
chance your dividends are subject to higher tax rates. A list of
holdings that aren't qualified include bond funds, emerging market
investments and real estate investment trusts.
Dividends on deposits don't count:
Another area that misses out: dividends paid on your deposits with
mutual savings banks, cooperatives, credit unions, and savings and loan
associations. All these are categorized as interest income and are
subject to your marginal tax rate. Check out a full list of other
unqualified dividends on IRS.gov.
The MLP mess:
Over the last few years, many investors have piled into master limited
partnerships in pursuit of big dividends. But MLPs are structured very
differently from your average corporation, since an MLP pays no tax
itself and is simply a pass-through entity. As a result, "distributions"
from these investments are not even considered dividends in any form by
the IRS; they are treated as a return of capital to a partner — even if
you only own one share So expect a different tax form (a K-1 instead of
a 1099) and a wholly different set of rules than fpr your typical
dividend investment. The National Association of Publicly Traded
Partnerships tries to unravel this in a handy tax guide that all MLP
investors should review if you need more clarification.
High wage earners beware: The
deal that averted the so-called "fiscal cliff" a few months ago brings
the first major tax increase on high earners in 20 years. If you have
more than $400,000 in taxable income or are filing as a couple with
$450,000, your top marginal tax rate has risen and so have your taxes on
long-term capital gains and dividends. If you're a high earner, keep
this in mind when you file your 2012 returns.
Qualified dividends are taxed at lower rates and charged on capital gains that can be between 0 and 15 percent. It has also low tax rate so investors can get the benefits with qualified dividends.
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