Chasing Dividends? Keep an Eye on Tax Reform
posted Sep 11, 2017 by Dave Desmarais, CPA/PFS, MST, MBA, AEP® in the Global Tax Blog
For years, the investment community has debated the merits of managing a portfolio for income (dividends) vs. total return (income plus price appreciation). Regardless of whether you’re chasing dividends, growth or a combination of the two, it’s critical to consider taxes when assessing an investment’s potential economic benefits.
Qualified vs. Nonqualified Dividends
When investing taxable funds in dividend-paying stocks, it’s important to understand the difference between qualified and nonqualified dividends. Nonqualified dividends are taxed at ordinary income rates, while qualified dividends are taxed at substantially lower capital gains rates.
Currently, capital gains rates are 20% for investors in the highest tax bracket and 15% for most other investors. Taxpayers in the two lowest brackets enjoy a 0% rate. Knowing whether stocks will yield qualified or nonqualified dividends allows you to compare investments based on their after-tax returns.
To qualify, dividends must be paid by a U.S. corporation or a qualified foreign corporation (one that’s organized in a country that’s a U.S. possession or tax treaty partner and meets certain other requirements). However, not all dividends paid by these corporations are qualified. To enjoy a reduced tax rate you must hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date (the cutoff on and after which new investors in the stock won’t receive a declared dividend).
Tax Reform Considerations
Although the timing and details of tax reform remain uncertain, there’s a strong possibility that tax changes will affect the analysis of dividend-paying stocks. For example, a Trump administration proposal would retain the favorable rate structure for qualified dividends. But his proposal would modify the tax brackets so the highest rate kicks in at lower income levels.
Currently, for married couples filing jointly, the qualified dividend rate jumps from 15% to 20% once income reaches $470,700. Trump’s proposal would lower that threshold to $225,000. That means a couple with income between $225,000 and $470,700 would see their tax rate on qualified dividend income increase by 5%.
If you’re considering investments in dividend-paying stocks, give us a call. Our private client services team can help you estimate the tax costs of these investments and evaluate the potential impact of tax reform on your investment strategies.