Author: William H. Byrnes & Benjamin S. Terner

Why is this Topic Important to Wealth Managers? Yesterday we presented an overview of the Obama Tax Cut provisions that are relevant to wealth managers.  Today we begin by taking a closer look at some of the details of those provisions and how they relate to wealth managers and their clients.

Section 102 of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR. 4853) provides for an extension of the regular and minimum tax rates for qualified dividend income and capital gains as were in effect before 2011.  The extension will continue for an additional two years.

To understand the impact of this provision of the new bill, it will serve the reader to understand what the regular and minimum tax rates in relation to qualified dividend income as well as capital gains means.

Qualified Dividends

Before the passage of the second major tax cut enacted by the prior administration, The Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends were taxed as ordinary income, and at ordinary income tax rates, to the taxpayer.  With the passage of Section 102 of the Obama Tax Cuts, the determination of tax liability with regards to qualified dividend income is taxed at the same rates as net capital gains.

Therefore, under Internal Revenue Code § 1(h), qualified dividends are tax at zero and fifteen percent.  Qualified dividends that would be taxed as ordinary income at an otherwise 10-15% rate, are taxed at zero percent, and qualified dividends that would ordinarily be taxed as ordinary income at 25% are taxed at a maximum of 15%.

Qualified dividend income, for this purpose means, dividends received during the taxable year from domestic corporations, and qualified foreign corporations.[1]

One important rule to note with regards to qualified dividend income is that shareholders must hold a share of stock for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date to be eligible for the reduced tax rates. [2]

Ex-dividend date generally means “the date on which the share of stock becomes ex-dividend”. [3] In other words, when a stock corporation declares a dividend, it also states the date of record, upon which the shareholder must own the stock on the company books to be paid the dividend.   “Once the company sets the record date, the stock exchanges or the National Association of Securities Dealers, Inc. fix the ex-dividend date. The ex-dividend date is normally set for stocks two business days before the record date.” [4]

Capital Gains

With the extension of the Tax Cuts, the maximum tax rate on the adjusted net capital gain of a taxpayer is 15%. [5] Adjusted net capital gain means the sum of:

(A) net capital gain (defined below and determined without regard to the calculation of adjusted net capital gain) reduced, but not below zero, by the sum of:
(i) any unrecaptured Section 1250 gain, and
(ii) 28-percent rate gain, plus
(B) qualified dividend income.  [6]

Net capital means the excess of the net long-term capital gain for the taxable year over the net short-term capital loss for such year.[7] Qualified dividend income was defined above and has the same meaning as applied here.

Section 1250 gains and 28-percent rate gains are defined in Internal Revenue Code Section 1(h) but are beyond the purview of this blogticle.  For additional discussion on Section 1250 and 28-percent rate gains see TAXFACTS 7524:  How is an individual taxed on capital gains and losses? Accessible through AdvisorFX with your online subscription.  For a free trial see AdvisorFX.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 U.S.C. § 1(h)(11)(B).

[2] 26 U.S.C. § 1(h)(11)(B)(iii).

[3] 26 U.S.C. § 1059(d)(4).

[4] Securities and Exchange Commission.  Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends. http://www.sec.gov/answers/dividen.htm.  Last Accessed 12/19/2010.

[5] HR. 4853, Section 102; 26 U.S.C. § 1(h).

[6] 26 U.S.C. § h(3).

[7] 26 U.S.C. § 1222 (11).

Tags: Capital gain, income tax, Internal Revenue Code, Jobs and Growth Tax Relief Reconciliation Act of 2003, Qualified dividend, Social Security, Tax, Tax rate

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