Information about Dividends Needed for the Series 7 Exam
Dividends may be in the form of cash, stock, or product. However, cash dividends are the only ones that are taxable in the year that they’re received. The following discussion is about dividends in cash, in stock, and from mutual funds.
Currently, qualified cash dividends received from stocks are taxed at either 0 percent, 15 percent, or 20 percent (0% on any amount that would otherwise be taxed at 10 percent or 15 percent; 15 percent on any amount that would otherwise be taxed at an amount over 15 percent but less than 39.6 percent; and 20 percent on any amount that would otherwise be taxed at the maximum tax rate of 39.6 percent), provided the customer has held onto the stock for at least 61 days.
The 61-day holding period starts 60 days prior to the ex-dividend date (the first day the stock trades without dividends). If the investor has held the stock for less than the 61-day holding period, he is taxed at the rate determined by his regular tax bracket.
Stock dividends don’t change the overall value of an investment, so the additional shares received are not taxed. However, stock dividends do lower the cost basis per share for tax purposes. The cost basis is used to calculate capital gains or losses.
Dividends from mutual funds
Dividends and interest generated from securities that are held in a mutual fund portfolio are passed through to investors and are taxed as either qualified (at a discounted rate) or nonqualified (at the rate determined by the investor’s tax bracket). The type(s) of securities in the portfolio and the length of time the fund held the securities dictate how the investor is taxed.
One of the great things about owning mutual funds is that they’re nice enough to let you know what taxes you’re going to be subject to. At the beginning of each year you will receive a statement from the mutual fund that lets you know how much you received the previous year in dividends, in short-term capital gains, and in long-term capital gains. The mutual fund also sends a copy of the statement to the IRS.
The mutual fund determines the long-term or short-term gains by its holding period, not the investors’. Also, remember that you’d be subject to capital gains tax and taxes on dividends even if the money were reinvested back into the fund.