Qualified Dividend Income Under the 2003 Tax Act

The 2003 Tax Act reduced federal income tax on certain dividend income, but it also changed the rules for deducting interest on investment properties. This means that for some taxpayers, the tax savings on dividends may not be worth the loss of deductions for interest expenses. Basically, Congress made a rule in 2003 that allows taxpayers to choose whether they want to pay lower taxes on their investment income or be able to deduct more of their investment interest expenses. This choice can be complicated because it has to be made every year and involves considering things like alternative minimum tax and other factors. Also, not all distributions from a company count as dividends for tax purposes, only certain kinds do. The 2003 Act allows most dividends from domestic corporations to be treated as qualified dividend income (QDI) for lower tax rates. However, dividends from certain types of corporations and payments in lieu of dividends are not eligible for QDI treatment. Shareholders who receive in-lieu-of payments, when their shares are borrowed by a broker, will be taxed at higher rates and should consider renegotiating their brokerage contracts to prevent this. Before 2003, only corporations had to differentiate between dividends and in-lieu of payments. Now, individual taxpayers also need to do this. The IRS allows taxpayers to rely on Forms 1099-DIV from their brokers to treat in-lieu-of payments as dividends unless they knew or had reason to know otherwise. The new law allows extraordinary dividends to count as qualified dividend income (QDI), but any loss on selling the shares is a long-term capital loss. Dividends from foreign corporations also get some tax benefits, but not as much as dividends from domestic corporations. A QFC (qualified foreign corporation) is a foreign corporation that meets certain criteria and is eligible for certain tax benefits in the U.S. These criteria include being incorporated in a U.S. possession, having a comprehensive income tax treaty with the U.S., and having stock that is easily traded on a U.S. securities market. The IRS has issued guidance on what qualifies as readily tradable stock and which income tax treaties meet the requirements. The IRS also plans to develop a program for foreign corporations to certify that they meet these requirements and to simplify reporting procedures. The PFIC rules may have a loophole that lets shareholders treat PFIC dividends as qualified dividend income (QDI). A PFIC can’t be a qualified foreign corporation (QFC) and its dividends can’t be QDI, but dividends from a controlled foreign corporation (CFC) can be QDI. A foreign corporation can be both a CFC and a PFIC. If a PFIC is also a CFC, the PFIC rules defer to the CFC rules and the shareholder can treat it as a QFC and its dividends as QDI. The 2003 Act also has rules about how long a taxpayer has to own the stock before its dividends can be QDI. The taxpayer has to hold the stock for a certain number of days during a window period that starts 60 days before the ex-dividend date. For preferred stock dividends that are held for more than 366 days, the holding period and window period are longer. It’s important for taxpayers to not count days when they’ve hedged their risk in a way that the law doesn’t allow. The SSRP test is more than just counting days. It checks if a taxpayer has reduced the risk of loss on stock through a hedge. The hedge must reflect the value of a single firm, industry, or economic factors. It’s easier to hedge stock portfolios with index positions than with single stocks. A pending bill would change the holding period requirements to allow taxpayers to buy stock the day before the ex-dividend date and still get tax benefits. The new tax law gives people who earn a lot of money from dividends a chance to pay less in taxes. But there are rules you have to follow to get the lower tax rates. If you trade stocks a lot, you might lose the tax benefits. Hedge funds also have to be careful with their trading and hedging strategies so their investors don’t lose out on tax benefits. Overall, it’s important to understand the rules before investing in stocks or hedge funds. The Jobs and Growth Tax Relief Reconciliation Act of 2003 changed the tax rules for investment income. It included qualified dividend income (QDI) in adjusted net capital gain, and taxed net capital gains at different rates based on a taxpayer’s income. The act also made changes to the alternative minimum tax (AMT) and allowed taxpayers to make an election on their investment interest expense deduction. The act also addressed issues related to dividends, including the holding period for stocks and the treatment of qualified dividend income. Some changes were proposed but had not been approved at the time of publication. This article talks about a law called the Working Families Tax Relief Act of 2004. It was signed by the President on October 4, 2004. The author, Nicholas Bogos, used to work for the IRS and now helps companies with tax issues. The article is submitted on behalf of the Tax Section. The law is meant to help working families with their taxes.

Source: https://www.floridabar.org/the-florida-bar-journal/qualified-dividend-income-under-the-2003-tax-act/