Great News If You Invest in Taxable Accounts

Dividends Now Taxed at Only 15% (Maybe Less). As long as anyone can remember, dividends paid on stocks held in taxable accounts were taxed as “ordinary income”. So, you paid your “regular” federal rate, which could be as high as 35% under the new law (down from 38.6% in 2002). Things have changed big time here.

• For all of 2003 through the bitter end of 2008, your qualified dividends from domestic corporations and qualified foreign corporations will be taxed at no more than 15% (the same as the new maximum rate on most long-term capital gains).
• If you happen to be in the 10% or 15% rate bracket (see the new rate table presented earlier in this letter), your dividends will be taxed at only 5%. (For 2008, your rate will be an unbeatable zero percent, but just for that single year.) Naturally, there’s a catch, but it’s not too bad. To be eligible for the new, drastically reduced rates on qualified dividend income, you must hold the stock on which the dividends are paid for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date (the last date on which shareholders of record are entitled to receive the upcoming dividend). If you fail this test, your dividends are taxed at your regular rate (up to 35%). Also, a slightly longer holding period applies to preferred stock.

Observation: Unfortunately, this change doesn’t help a bit for dividends received by tax-deferred retirement accounts (such as 401(k), SEP, Keogh, and traditional IRAs). Dividends that you accumulate in these tax-deferred accounts will still be taxed at your regular rate (up to 35%) when withdrawn as cash distributions. (As before, dividends accumulated in Roth IRAs can be withdrawn tax-free if you meet certain guidelines.)

Needless to say, the dividend break has a sunset rule too. Unless Congress acts, dividends received in 2009 and beyond will once again be taxed at your regular rate.

Ditto for Long-term Capital Gains. We have more good news. If you invest in securities via taxable accounts, your long-term capital gains from sales after May 5, 2003 will be taxed at no more than 15% (down from 20% under prior law). Those in the 10% or 15% rate brackets will pay only 5% on long-term gains from sales after the magic date (in 2008, the rate will be zero percent, but just for that one year). These same much-reduced rates also apply to the long-term capital gain component of installment sale payments you receive after May 5th of this year. So far, so very good. However, the rates for certain types of gains were not reduced by the 2003 Act.

• A maximum rate of 25% remains in effect for long-term real estate gains attributable to depreciation deductions claimed against your property (?unrecaptured Section 1250 gains?).
• A maximum rate of 28% remains for long-term gains from sales of collectibles and certain small business stock.
• Finally, long-term capital gains from sales that occurred before May 6 of this year will be taxed at the old-law rates (20% maximum rate for gains in the higher brackets, 10% maximum rate for gains within the 10% and 15% brackets, 8% for five-year gains within the 10% and 15% brackets).

Observation: The new, lower capital gains rates don’t apply to investments held in tax-deferred retirement accounts (such as 401(k), SEP, Keogh, and traditional IRAs). Gains that you accumulate in these tax-deferred accounts will still be taxed at your regular rate (up to 35%) when withdrawn as cash distributions. (As before, gains accumulated in Roth IRAs can be withdrawn tax-free if you meet certain guidelines.)

One more thing: unless Congress acts, long-term capital gains will once again be taxed under the “old rules” in 2009 and beyond.