There are dividend tax terms to be aware of when you receive your 1099-DIV form in February. Learn the differences between ordinary versus qualified dividends here.
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 master plan pay dividends—literally.
But there’s one more thing you have 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 TD Ameritrade along with a consolidated 1099 form. The document should arrive by February 23, 2023, depending on your trading activity and the dividend issuer’s tendency to reallocate (we’ll get to that later). Learn more about broker deadlines.
In a perfect world, completing your taxes would be easy and all your dividends would match your monthly statements. Unfortunately, doing your taxes isn’t always that easy—and there are a few common pitfalls you need to understand about dividend taxes before submitting your returns.
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 are the same. They’re not (see figure 1). If, however, all your dividends are eligible for the qualified rate, 100% of your ordinary dividends would also be reported as qualified dividends.
FIGURE 1: ORDINARY DIVIDENDS VS. QUALIFIED DIVIDENDS. Not all ordinary dividends are eligible for a qualified dividend rate. Dividend classification is determined by the dividend issuer. However, other criteria—recipient holding period, for example—must also be considered. For illustrative purposes only.
This can happen for a number of reasons; for example, if a 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 (see figure 2). 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.
Let’s say you paid $10,000 for a security and that security makes a $500 payment. 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 like ordinary dividends.
FIGURE 2: DIVIDENDS AND DISTRIBUTIONS DETAILED. Details for each reportable item are categorized by issuer and date. A single payment may be broken into multiple tax classifications (qualified and nonqualified distributions, as well as nondividend distributions). For illustrative purposes only.
Other financial buzzwords you might see on the 1099-DIV include cash and noncash liquidation distributions, investment expenses, and foreign tax withheld. It’s important to read—and understand—the documentation provided by the issuer to understand 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 all year, your dividends were credited to your account as qualified dividends. 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 a form on January 15 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. Learn more about corrected forms here.
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 20, 2022, who get a dividend credited to their account on January 15, 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 pay 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.
It’s often difficult to anticipate an issuer’s tax classification for dividends prior to their final say. Historical reporting gives us an idea what issuers are likely to report; however, it would be impossible for your broker to guarantee that a security has completed reallocation. Our vendors and in-house data analytics do everything they can to avoid inaccuracies and unnecessary form corrections. That said, the better you understand your consolidated form, the better prepared you can be to finish your tax year strong.
TD Ameritrade does not provide tax advice. We suggest that you seek the advice of a qualified tax-planning professional with regard to your personal circumstances.
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