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CHECK OUT NEW INPUT FROM THE IRS ON âQUALIFIEDâ DIVIDENDS
Tip of the Month
November 2003
CHECK OUT NEW INPUT FROM THE IRS ON âQUALIFIEDâ DIVIDENDS
The tax cuts announced in May lowered the top tax rate on dividends to 15 percent from
38.6 percent. It sounds pretty straightforward doesnât it? However, when it comes to what constitutes a âqualifiedâ dividend, complications abound. The Internal Revenue Service (IRS) continues to clarify âgrayâ areas to help investors better understand when dividends qualify for the new favorable tax rates.
Recently, the IRS provided more input on dividend income related to short sales and on âqualifiedâ foreign corporations. Hereâs an update:
Short Selling
Questions still remain, but in Notice 2003-67, the IRS addresses short sales. Because the lender (short seller) no longer owns the stock (as per Section 316 of the new tax legislation), the payments the short seller receives from the borrower in lieu of dividends should not be eligible for the reduced tax rate under the new lawâs definition of dividends. However, because the law was passed mid-year, the IRS has recognized that brokers may not yet have had sufficient time to change the way they report these payments to clients. Because of this, the IRS does not intend to penalize those clients whose brokers have not yet updated their systems to correctly identify such payments âas in lieu of dividendsâ. This grace period extends only until the end of this year, and the temporary waiver of penalties applies only if a brokerage firm can show a good faith effort to comply.
Furthermore, the IRS will allow taxpayers to treat such payments received in lieu of dividends as if they were dividends, if they are reported by the broker on Form 1099-DIV to the customer as âdividend incomeâ andâand this is a big â andââunless the brokerâs client âknows, or has reason to know, that the payments are made in lieu of dividendsâ. If you find this IRS update somewhat confusingâand it isâwe recommend that you ask your tax professional to keep you posted, and that you seek expert tax advice on this issue prior to the tax season onslaught.
Qualified Foreign Corporations
The IRS has provided more information on the issue of when, and under what circumstances, a company based outside the U.S. may be considered a âqualified foreign corporationâ and the dividend payments it makes to U.S. taxpayers eligible for the new rates.
What does it take to be considered âqualifiedâ? For the most part, a qualified foreign corporation may be defined as a foreign company located in a country that has a comprehensive tax treaty with the U.S. The U.S. Treasury Secretary determines what constitutes a satisfactory tax treaty âand it must include a program that permits exchange of information between treaty partners. IRSâ Notice 2003-69 lists the countries considered âqualifiedâ. Note that Barbados, Bermuda, Russia and the Netherlands Antilles currently are excluded from this list.
If the foreign company stock yielding a dividend is readily tradable on an established U.S. securities exchange, the IRS also deems a foreign company âqualifiedâ. At this time, the IRS considers the following to be established exchanges: the NYSE; Nasdaq; and Amex plus the regional exchanges in Chicago, Cincinnati, Boston, Philadelphia and the Pacific Exchange.
We expect the IRS will continue to provide more clarification on dividend taxation issues. Please contact us for further advice, if you have any questions or comments.
38.6 percent. It sounds pretty straightforward doesnât it? However, when it comes to what constitutes a âqualifiedâ dividend, complications abound. The Internal Revenue Service (IRS) continues to clarify âgrayâ areas to help investors better understand when dividends qualify for the new favorable tax rates.
Recently, the IRS provided more input on dividend income related to short sales and on âqualifiedâ foreign corporations. Hereâs an update:
Short Selling
Questions still remain, but in Notice 2003-67, the IRS addresses short sales. Because the lender (short seller) no longer owns the stock (as per Section 316 of the new tax legislation), the payments the short seller receives from the borrower in lieu of dividends should not be eligible for the reduced tax rate under the new lawâs definition of dividends. However, because the law was passed mid-year, the IRS has recognized that brokers may not yet have had sufficient time to change the way they report these payments to clients. Because of this, the IRS does not intend to penalize those clients whose brokers have not yet updated their systems to correctly identify such payments âas in lieu of dividendsâ. This grace period extends only until the end of this year, and the temporary waiver of penalties applies only if a brokerage firm can show a good faith effort to comply.
Furthermore, the IRS will allow taxpayers to treat such payments received in lieu of dividends as if they were dividends, if they are reported by the broker on Form 1099-DIV to the customer as âdividend incomeâ andâand this is a big â andââunless the brokerâs client âknows, or has reason to know, that the payments are made in lieu of dividendsâ. If you find this IRS update somewhat confusingâand it isâwe recommend that you ask your tax professional to keep you posted, and that you seek expert tax advice on this issue prior to the tax season onslaught.
Qualified Foreign Corporations
The IRS has provided more information on the issue of when, and under what circumstances, a company based outside the U.S. may be considered a âqualified foreign corporationâ and the dividend payments it makes to U.S. taxpayers eligible for the new rates.
What does it take to be considered âqualifiedâ? For the most part, a qualified foreign corporation may be defined as a foreign company located in a country that has a comprehensive tax treaty with the U.S. The U.S. Treasury Secretary determines what constitutes a satisfactory tax treaty âand it must include a program that permits exchange of information between treaty partners. IRSâ Notice 2003-69 lists the countries considered âqualifiedâ. Note that Barbados, Bermuda, Russia and the Netherlands Antilles currently are excluded from this list.
If the foreign company stock yielding a dividend is readily tradable on an established U.S. securities exchange, the IRS also deems a foreign company âqualifiedâ. At this time, the IRS considers the following to be established exchanges: the NYSE; Nasdaq; and Amex plus the regional exchanges in Chicago, Cincinnati, Boston, Philadelphia and the Pacific Exchange.
We expect the IRS will continue to provide more clarification on dividend taxation issues. Please contact us for further advice, if you have any questions or comments.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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