Are Dividends Received on Preferred Stock Treated As Qualified Dividends?
The classification of stock dividends have tax implications for dividend recipients. Qualified dividends are taxed at the lower rates that apply to long-term capital gains. Depending on the regular tax bracket that an investor is in, qualified dividends are subject to a tax rate of zero to 15 percent. Suppose the recipient of a qualified dividend has a regular tax rate lower than 25 percent, the zero tax rate would be applied on the qualified dividends. However, stock dividends can also be ordinary dividends if they do not meet certain conditions. Dividends received on preferred stock are not automatically treated as qualified dividends.
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Required Stock Holding Period
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Shareholders are qualified to receive dividend payments as long as they are on the shareholder list by the record date as declared by the board of directors each time it pays a dividend, no matter when they bought the stock. For example, an investor could buy a stock right before the record date and sell it the next day, and would still qualify for the dividend payment. However, under a holding-period rule, the dividend received would not be considered as a qualified dividend for tax purposes. For preferred stock, the rule prescribes that the stock should be held for more than 90 days during a 181-day period that starts 90 days before the ex-dividend date, which is two days prior to the record date.
Certain Unqualified Dividends
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Certain dividends are not qualified dividends even though they meet the requirement for the holding period. Dividends distributed by tax-exempt corporations, such as real estate investment trusts, are reported as ordinary income and taxed at the highest personal tax rate. Dividends paid on an employer's stock are also not qualified dividends if the stock is held by the employer under the employee stock ownership plan as opposed to being bought on the open market and held by a broker.
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Stock Issuing Corporations
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Under United States tax law, qualified dividends must be paid by a United States corporation or a qualified foreign corporation. A foreign corporation incorporated in the United States is considered a qualified foreign corporation. For a foreign corporation not incorporated in the United States, in order to be eligible for qualified dividends, its home country must have a comprehensive tax treaty for the dividends distributed to a United States' shareholder. A non-U.S. incorporated foreign corporation that has no comprehensive tax treaty with the United States can still have qualified dividends if the stock, such as the preferred stock on which the dividends are received, are readily traded on an established United States' stock market.
Rules of Exceptions
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If a preferred dividend is due to a period less than 367 days, the required holding period for the stock can be shortened to 60 days from 90 within a reduced time window of 121 days from 181 days. Qualified foreign corporations do not include passive foreign investment companies, and any dividends received on such investments are not qualified dividends. Any payments in lieu of dividends that the shareholder knows, or has reason to know, that they are not qualified dividends shall be reported as ordinary income.
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