Dividends are payments that a corporation distributes to the shareholders, often quarterly but at least annually. Not all public companies pay dividends, but some pay them reliably. Some examples include Exxon Mobil, Verizon, Enbridge, VF Corp, Unilever, and 3M. In addition, some companies have a long history of paying dividends, including DuPont, Edison, General Mills, Eli Lilly, and Stanley Black & Decker. Dividend-oriented investors may rely on these payments, and some companies have encountered an investor backlash when they have reduced or dropped their dividends (often due to financial hardship).
How are dividends taxed?
Some dividends are taxed as ordinary income, while others qualify for the same rate as long-term capital gains, which is more favorable. Whether you pay the regular income (higher) rate or the lower capital gains percentage depends on several things.
First, the company issuing the dividend can't be expressly excluded from qualifying. Most U.S. companies qualify, and some foreign firms. For foreign corporations, the company can qualify by meeting one of these three conditions:
- It is incorporated in a U.S. possession. U.S. territories like Guam and Puerto Rico are familiar possessions, but some lesser-known examples are Navassa Island, Jarvis Island, and Baker & Howland Islands.
- The stock is widely traded on a U.S. exchange.
- The corporation is in a country with a comprehensive income tax treaty with the U.S. Examples include Canada, China, Sri Lanka, Sweden, Switzerland, Iceland, Israel, Italy, and Japan.
Second, the taxpayer must meet the holding requirements. For example, suppose you have held the dividend-paying security for at least 60 days before the ex-dividend date (the business day before the dividend is announced). In that case, the dividend income is considered qualified and will be taxed at the lower long-term capital gains rate. Also, if the stock type is preferred rather than common, the holding period increases to 90 of the 181 days before the ex-dividend date. This provision is in place because preferred stock lacks voting rights but pays dividends before common stock does.
If the investor hedges the stock during the holding period, any dividends are automatically disqualified. Hedging means the investor used strategies such as puts, calls, or short sales.
Is a dividend the same as a capital gain?
Capital gains are only realized when the investor sells the asset. For example, a stock may enjoy a tremendous increase in value, but if the investor doesn’t sell it, they do not owe taxes on that appreciation. In contrast, dividend income is taxable in the year the investor receives it.
What dividends are excluded from qualification?
Employee stock options are typically not eligible for the lower tax rate, and in most cases, distributions from Real Estate Investment Trusts (REITs) and master limited partnerships are excluded. However, the Tax Cuts and Jobs Act allowed a deduction of 20 percent of pass-through business income, including income from REIT distributions. This special deduction expires at the end of 2026 but currently can aid in reducing the effective tax rate.
Also, suppose a REIT has activities that generate income but are outside the scope of real estate (which is allowed up to 75 percent). In that case, the income attributed to those activities is potentially eligible for the lower, qualified rate.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
The income stream and depreciation schedule for any investment property may affect the property owner's income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time.
A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.
REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
There are risks associated with these types of investments and include but are not limited to the following:
- Typically, no secondary market exists for the security listed above.
- Potential difficulty discerning between routine interest payments and principal repayment.
- Redemption price of a REIT may be worth more or less than the original price paid.
- Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.
- There is no guarantee you will receive any income.
- Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.
This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.
