Qualified Dividend — Reduce Your Tax Burden

Dividend income can be significant for retirees and other investors who actively seek dividend paying stocks. But dividends can also be taxed as ordinary income if you're not careful about when you buy and sell the stock.

In order to reap the maximum tax benefit when it comes to dividend taxation, you must understand an important concept — qualified dividend — which is different from ordinary income.

Even though the discussion below pertains to how dividends are taxed in the U.S., the concepts are similar across several other countries.

What Is A Qualified Dividend?

In a nutshell this is an ordinary dividend that is subject to a lower tax rate .... the same lower tax rate as long-term capital gains (0% if you're under the 25% tax bracket, 15% otherwise).

According to IRS (Internal Revenue Service) Publication 550, there are certain conditions that must be met for a dividend to be treated as a qualified dividend:

• The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. In general, a qualified foreign corporation is a foreign corporation traded on any of the US stock exchanges.

• The dividends are not of the type that the IRS lists separately as "dividends that are not qualified dividends" like dividends paid out by tax-exempt organizations, employee stock option plans, etc.

• You meet the holding period.

  The IRS is very specific about the holding period..... "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. When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it."


An Example

The definition of holding period sounds rather confusing. Let's look at an example to clear things up.

You just got done with the monumental task of spring cleaning your house. You were so impressed with the Clorox products you used that you decided to go out and buy stock in The Clorox Company.

You bought 1,000 shares of common stock in Clorox (CLX) on March 24, 2010. Shortly afterward, CLX announces a dividend of 50 cents a share with an ex-dividend date of April 26, 2010.

Now let's determine the holding period. First, we calculate the start of the 121-day period, which begins 60 days before the ex-dividend date. That brings us to Feb. 25, 2010. Next, the 121-day period end date, which brings us to June 25, 2010 (121 days from Feb. 25).

As long as you hold your shares for more than 60 days within this window of Feb 25 - June 25, your dividend will not be taxed as ordinary dividends!

Now you've bought CLX on March 24. 60 days from your purchase date takes you to May 23, 2010. Both March 24 and May 23 are within the 121-day window. As long as you sell your stock after May 23, 2010, your dividends will qualify for the lower tax rate.





To wrap up, we've looked at how dividends can be treated as ordinary incurring higher tax rates or qualified which are taxed at a lower rate. We reviewed, with an example, the IRS guidelines to determine what kind of dividend you earn.

We hope you will be able to use this essential tax-saving information to your benefit the next time you make a dividend-paying stock purchase.

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