March 2004 On-line Tax Planning
Interest and Dividend
Income
New tax laws have made it
increasingly difficult to properly classify and report interest and dividends.
Not only is there
interest and tax-exempt interest, but also tax-exempt interest from private
activity bonds, original issue discount bonds and even something called imputed
interest. On the dividend side, we have
qualified dividends, dividends that would be qualified except that you haven’t
held the stock long enough, non-qualified dividends, qualified foreign dividends
and an unusual type of income called a "payment in lieu of dividends."
Depending on your type of entity, that also makes a
difference. To all the C Corporations out there - this does not
fully apply to you because you don’t get a break on dividend income any more
than you get a break on capital gains. Only
individuals will get to use the lower dividend and capital gain rates and, since
their income is passed through to the individual, S Corporations,
Partnerships and LLCs will need to identify the
different types of income.
Interest
Let’s begin with the various income tax returns one
might file and where interest and dividend income are reported on those forms.
For individuals, interest will generally be reported on either line 8a or 8b of
Form 1040. Depending on the amount of interest,
you may also be required to file Schedule B to your 1040. Generally,
you must file a Schedule B if you had over $1,500 of taxable interest or
dividends, claim an exclusion of interest from series EE or I U.S. Savings Bonds
issued after 1989, received ordinary dividends as a nominee or had a foreign
account or received distributions from a foreign trust. If
you received interest as a nominee or from a seller-financed mortgage, you will
also need to file a Schedule B.
Where you are required to enter income from interest is extremely important.
Taxable interest goes on line 8a and is included
in the computation of taxable income. Tax-exempt
interest and tax-exempt interest received as dividends from mutual funds are
reported on line 8b. For income tax purposes,
there is no tax on tax-exempt interest, but the Alternative Minimum Tax does tax
any tax-exempt interest from private activity bonds. For
an individual, Alternative Minimum taxable interest is reported on Line 11 of
Form 6251. Don’t worry about how you will figure
out how much private activity interest you had, your annual 1099-INT and
1099-DIV will tell you.
Have you bought any corporate or U.S. Government bonds
that were issued at a discount. This happens
when the stated interest rate is less than the going market rate or, sometimes,
bonds are issued at a low value and mature many years later with the difference
between the purchase price and maturity value being the interest return on the
bond. If you have these kinds of bonds, you most
likely have an item on your 1099-INT called Original Issue Discount ("OID").
Essentially, what the brokerage house is doing
is recording a little bit of the OID as interest each year until the bond
reaches maturity. Then, when the bond matures,
there is no gain or loss - in theory. In the real world, calling bonds or other
dispositions of OID bonds quite often results in a gain or loss.
Don’t be fooled by the term tax-exempt. Interest
may be tax-exempt, but you still have to report it on your return.
There are some tax calculations that add
tax-exempt interest to other income to determine the taxability of income.
Most prominent is the inclusion of Social
Security benefits in income.
If you are looking at the tax return of a pass-through entity like an S
Corporation or a Partnership, you will first see the interest on Schedule K of
those returns. In turn, each
partner/shareholder/member will receive a K-1 with their share of income,
including interest and dividends, on it.
Dividends
If you have dividend income, chances are you received a 1099-DIV from either the
payer of the dividend or your broker. The
company that sends the 1099-DIV should tell you on the 1099 whether dividends
are qualified or not.
Simply put, a qualified dividend is a dividend
that is taxed at a maximum of 15% (5% for those in a tax bracket of less than
25%), but for a dividend to qualify for the lower rates, it
must also meet certain "holding period" requirements..
In order for a dividend to qualify, the stock on which the dividend is paid must
be held for more than 60 days in the 120-day period that begins 60 days before
the ex-dividend date and 60 days after the ex-dividend date. The
ex-dividend date is the first date following the declaration of a dividend that
the buyer of a stock will not receive that dividend. It
gets a little trickier for certain preferred stock. We will be glad to discuss
the various rules with you.
Another little rule you will have to remember is that dividends from foreign
corporations do not qualify for the lower rate, unless they are from certain
countries. You can find a list of these
countries in IRS Publication 17 at the IRS website.
There are certain types of corporations that pay dividends that are specifically
excluded from the qualified dividend category. You
can find a list of these entities in Publication 17. In
addition, there are several other types of dividends, including, payments in
lieu of dividends, that may not qualify for the lower rates. Payments in lieu of
dividends result when a brokerage company "borrows" your stock and a dividend is
paid while the brokerage has your stock. Since you don’t get the dividend, the
brokerage pays you what you would have received and calls the deal even.
The only problem is it can cost you tax and you
basically have no control over when a brokerage will borrow the stock.
Finally, let’s get to the reporting requirements.
You already know about the rules for Schedule B,
so all you need to know now is that taxable dividend income is reported on 9a in
total and the portion of line 9a that qualifies for the lower rate is included
on line 9b. As with interest, if you have
dividend income coming from a pass-through entity, you will get a K-1 telling
you how much dividend income you need to report.
Conclusion
If you have dividend or interest income, perhaps it’s time to give us a call.
Let us 1) help you understand the law and
2) help you best plan to take advantage of the current
tax law. Perhaps that will help you avoid a
headache on April 15.
Tax
Planning Archives
For More Information Contact:
Bucheri McCarty & Metz LLP
2366 W. Boulevard
P.O. Box 2147
Kokomo, IN 46904-2147
Telephone: (765) 236-2300
FAX: (765) 236-2333
Internet:
info@bmmcpas.com
