In prior lessons, you learned that non-liquidating distributions of
after-tax profits can take many forms such as cash,
property, stock, and constructive elements like excessive compensation.
You also learned that the distribution to the extent of current and accumulated E&P is
a dividend for tax purposes that is generally included in a shareholder's gross income,
but what tax rates apply?
In general, the tax treatment of dividends depends on whether
the shareholder receiving them is another corporation or not.
All corporations treat dividends as ordinary income,
but received some tax relief from the dividends received
deduction if certain ownership and other conditions are met.
Individual shareholders, however, apply preferential tax rates to
so-called qualified dividends and ordinary tax rates to non-qualified dividends.
This lesson you will learn about the taxation of qualified dividends,
a concept introduced as part of an economic stimulus legislation in the early 2000s.
Dividends are important and often controversial tax issue
because they form the basis of double taxation.
Some commentators claim that taxing both corporate income
and dividends incentivizes investors to invest in
non-corporate forms and motivates corporations to finance operations
with debt rather than equity to attain tax deductions for interest expense.
Others argue that the taxation of dividends helps regulate
the concentration of economic power held by publicly traded corporations.
There are many other arguments both for and against the taxation of dividends.
However, one argument in particular that seems to resonate with Congress is that
many of the US's trading partners only assess tax at the corporate level.
Thus, some argue that eliminating
the double tax would make the U.S. more globally competitive.
As somewhat of a compromise between elimination of
double taxation and treating dividends as ordinary income,
Congress provides for a reduced tax rate on so-called qualified dividends.
To be considered qualified,
a dividend must first be paid by a domestic corporation,
dividends from foreign corporations are permitted if they meet
several tax treaty and information sharing agreements with the U.S. government.
A dividend must also be paid on stock that has been held greater than 60 days during
the 121-day period beginning the 60 days before the ex-dividend date.
Note that the ex-dividend date,
which determines who receives a dividend when stock is trading near
the distribution date is typically two days before the date of record on a dividend.
Finally, the dividend cannot be paid to
a shareholder who owns both long and short positions in the stock.
Qualified dividends are subject to
a maximum tax rate of 20 percent for individual taxpayers.
Notice that this is a maximum rate.
In fact, in 2018,
qualified dividends are exempt from tax,
that is subject to a zero percent tax rate,
for single taxpayers would taxable income up to $38,600 or $77,200 for joint filers.
In contrast, the 20 percent tax rate on
qualified dividends applies to single taxpayers with
taxable income over $425,800 or $479,000 for joint filers.
Other taxpayers in between generally pay a 15 percent tax rate on qualified dividends.
These preferential tax rates apply only to individuals.
Corporations still treat dividends as
ordinary income potentially subject to the dividends received deduction.