To Reduce Your US Tax Bill, Keep Dividends Qualified
Paul Robertson and Tuppence Russo
The recently passed American Tax Relief Act (ATRA) raised the top tax rate for qualified dividends, but it scarcely affected the benefit this rate provides to investors. That’s because ATRA also raised the top tax rate on ordinary income—the rate investors have to pay for nonqualified dividends—by nearly as much.
The gap between the top marginal US income tax rate (43.4%) and the top qualified dividend rate (23.8%) now stands at 19.6%. This means that the after-tax return for a stock with a 2% dividend will be roughly 0.4% higher if the dividend qualifies for the lower tax rate. In the case of a special dividend, let’s say at the 5% level, the after-tax return would be almost a full percentage point higher.
To qualify, a common stock dividend must be paid by either a US corporation or a foreign corporation that has shares that trade on a US exchange and is located in a country that has a tax treaty with the US. Furthermore, the investor must hold the stock for 61 days or more in the 121-day period that begins 60 days before the ex-dividend date (the date that determines whether the seller or buyer of a stock will be entitled to the dividend).
Let’s suppose that an investor has found a very promising stock and, in order to buy it, wants to sell a dividend-paying stock that she’s held for just 50 days. Does it make sense to sell this stock right away and forgo the lower tax rate? What would it cost to delay the trade for 10 days? Tax-aware investors and portfolio managers need to be able to answer these questions each and every time they arise.
Tax-aware trading of dividend-paying stocks can save money in virtually every taxable investment account, and investors in lower tax brackets can benefit, as well. In every case, the size of the benefit will depend on the difference between the ordinary income tax rate and the qualified dividend rate that the particular investor will have to pay.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Paul Robertson is a Senior Portfolio Manager and Tuppence Russo is Director of the Private Client Portfolio Management Group, both at Bernstein Global Wealth Management, a unit of AllianceBernstein.