History

• In 2003, the U.S. Congress passed and the President signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003. The law reduced the maximum income tax rate on qualified stock dividends to either 5 or 15 percent, depending on the taxpayer's marginal tax bracket. Before the Act, dividends were taxed at the same rate as ordinary income. In 2008, a zero percent bracket was added to the dividend tax rate for investors in the lowest income tax bracket.
  
  

Significance

• The Act of 2003 reduced the double taxation of corporate income. Corporations were paying corporate income tax on their earnings, then when the earnings were distributed to shareholders as dividends, they were taxed again to the shareholders. Reducing the tax rate on dividends made stocks that paid out earnings to shareholders more attractive.
  
  

Types

• Stock dividends are either qualified for the lower tax rates or non-qualified. Qualified dividends come from corporations that pay regular corporate income taxes. Non-qualified dividends come from companies that are formed under special tax rules that allow them to not pay income tax if they pay out most of their earnings to shareholders. Real estate investment trust (REIT) and master limited partnership (MLP) companies are created under these laws and pay non-qualified dividends.
  
  

Identification

• The companies that pay dividends to shareholders will send out an Internal Revenue Service Form 1099-DIV at the end of the year to report the total dividends paid for the year. The 1099-DIV has separate boxes for qualified and non-qualified dividends. The qualified dividends will be taxed at the lower rates and the non-qualified ones are taxed at the shareholders regular income tax rate. Many high-yield stocks fall into the categories that pay non-qualified dividends. If you are considering a stock with trust or partnership in the name, contact the company's investor relations department to learn the status of the company's dividends.
  
  

Warning

• The income tax provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 expire at the end of 2010. Unless the U.S. Congress extends the law, dividends will be taxed at the shareholder's highest, marginal tax rate starting in 2011. Shareholders of stocks that pay currently qualified dividends should be aware of the tax consequences of their investments when the law expires.