When corporations make a profit, their owners have a means of taking possession of those funds. It’s called a dividend, the amount of which is determined by the firm’s Board of Directors.
When a company is private and relatively small, this is not a big bureaucratic challenge. In fact, most small corporations are run by their owners, who tend to reward themselves via bonuses, which are a payroll tool rather than being related to capitalization. But with larger companies in which ownership is spread over a large base of stockholders, sharing the profits becomes more complex.
The means of doing this is by paying a dividend, or an amount-per-share. These payments become taxable income to the recipients.
Dividends are Taxable as Income
However, the Internal Revenue Service, in an effort to provide tax relief to low income citizens, has created special provisions, which, under certain conditions, allow some dividend recipients to avoid or lower their tax obligations on the dividends they receive.
When those conditions apply, the profit-sharing payment is known as a qualified dividend.
Conditions for Qualified Tax Dividends
Qualified dividends are ordinary dividends that meet certain conditions. They are:
o dividends that were paid out between 1-1-03 and 12-31-2010;
o paid from a U.S. Corporation, or a company associated with the U.S. in an official way;
o the stock on which the dividend is paid was owned by the recipient for 60 days prior to the ex-dividend date and held for 59 days after the payment date.
The latter rule is intended to discourage investors from buying dividends just before the payment, and then selling them right after the payment, for the sole purpose of avoiding taxes.
Depending on the income bracket of the recipient, taxes on qualified dividends range from 5 to 15 percent, as compared to as much as 38% on high personal incomes.
As you can see, this program does deliver tax savings on qualified dividends, provided these conditions exist.
Consult your tax professional before making any investment or tax decisions associated with the issue of dividends, qualified or otherwise.