You've worked all year to get your long-term portfolio just right by researching yields and allocating your assets. Now you're ready to sit back and hope your plan pays dividends—literally.
But there's one more thing to do before closing your books: You have to give Uncle Sam his cut.
If you're a U.S. taxpayer with at least $10 in dividend income, you'll receive a 1099-DIV form from your brokerage, along with a consolidated 1099 form.
In a perfect world, completing your taxes would be easy and all your dividends would match your monthly statements. Unfortunately, filing your taxes isn't always that easy—and there are a few common pitfalls you need to understand about dividend taxes before submitting your return.
What are "ordinary" vs. "qualified" dividends?
You might see terms like "ordinary," "qualified," and "nonqualified" on your 1099-DIV form, depending on the dividend issuer’s designation. These terms are there for a reason. Dividends are considered ordinary dividends, meaning they're taxable as ordinary income. Some (but not all) dividends are eligible for a qualified tax rate, typically at one's capital gains rate.
So, what makes a dividend qualified? There are two criteria: The issuer needs to classify the dividend as qualified, and you need to meet the holding requirements set by the Internal Revenue Service (IRS) to be eligible to claim the qualified rate.
Taxpayers often believe they're victims of duplicate reporting when the figures in Line 1a (ordinary dividends) and 1b (qualified dividends) on the 1099-DIV form are the same. They’re not. If, however, all your dividends are eligible for the qualified rate, 100% of your ordinary dividends would also be reported as qualified dividends.
For illustrative purposes only.
This can happen for a number of reasons; for example, if an investment product passes through its long-term and short-term capital gains when assets are bought and sold at a profit. As far as credits to your account go, this will look like any other dividend. For the purposes of taxation, these are handled differently.
Another item that tends to confuse taxpayers is the return of capital (ROC) or "nondividend distribution" variety of payment also listed on the 1099-DIV. These distributions are nontaxable in the sense that they're not included in your dividend income, but they'll be used as a cost basis adjustment against the underlying asset.
Example: Let's say you paid $10,000 for a security and that security makes a payment of $500. Later that year, the issuer gives notice that this payment will be classified as ROC for taxation purposes. Instead of claiming that payment as income, the payment amount is used to decrease your cost, adjusting your tax basis for this security to $9,500. In this scenario, the tax burden is deferred until the sale or other disposition of the security (whenever that may be), not when the payment is received, as is the case with ordinary dividends.
Other classifications on the 1099-DIV include cash and non-cash liquidation distributions, investment expenses, and foreign tax withheld. It's important to read—and understand—the documentation provided by the issuer to know what these terms mean and why they're being passed along to you.
Ever wonder why your broker doesn't issue a tax form on January 1 or even by January 31? It's often because of income reallocation.
Let's say your dividends were credited to your account as qualified dividends all year. So, imagine your surprise when you receive a 1099-DIV form and that same $200 dividend is now 50% qualified and 50% nonqualified. What happened? Many times, the dividend issuers don’t get together to finalize their dividend classification until January or February of the next year, sometimes even later.
Why would your brokers issue you a form in January when they know that a dividend-issuing company in which you hold stock routinely reallocates on January 31? This type of change is common and a large contributor to the perceived delay in receiving your form. Issuers actually have up to three years to reallocate their payments.
Another frequent source of confusion is when a dividend you received from your mutual fund or Real Estate Investment Trust (REIT) in January shows up on your prior year’s form. For example, owners of record holding security XYZ as of December 2022 who get a dividend credited to their account on January 2023 shouldn't have to pay taxes on that income until 2023, right?
Unfortunately, no. This type of dividend is called a spillover dividend because the issuer is using the declaration date, not the payment date, as a point of reference for tax reporting purposes. In effect, the payment falls into next year's statement but is very much taxable for the prior year. This is one of many reasons we don't suggest doing your taxes before you receive your 1099-DIV.
Are stock dividends taxable?
Periodically, you'll see an entry on your 1099-DIV form that doesn't match any cash credited to the account. Before you call your broker, look at any new stock credited on or around that date within your monthly statement. Many times, the value you're seeing is equal to the fair market value of the stock you received from that issuer.
It's often difficult to anticipate an issuer's tax classification for dividends prior to its final decision, and initial 1099-DIV forms are sometimes corrected later. As an investor, your best choice can often be to wait until you get your final, corrected 1099s, even if you start preparing your return earlier. For more guidance, consult with your tax professional.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.0223-3ECP