As April 15 approaches, many investors are realizing that a
lot of their gains have a date with the IRS. When it comes to
personal finance, tax efficiency is important to keeping as much
of your gains as possible. For income investors, knowing certain
tax rules can make tax time a lot less painful and allow you to
keep more of what you gained.
Interest vs dividends
Regarding total income amounts, there is a lot in common between
interest payments and dividend payments. But for the purposes of
taxes, they are treated very differently. Interest income is
taxed at your ordinary income tax rate while qualified dividend
income is taxed at a (usually) lower tax rate.
For investors looking at preferred stocks, the difference here
can be critical. Often mixed in with preferred stocks are
exchange traded debt securities, which pay interest instead of
Take these insurance examples for instance.
Aegon 8.00% Non-cumulative subordinated notes
show up alongside preferred stocks in many screeners. But this
issue is made up of debt securities that pay interest, not
dividends, and therefore have the payments taxed at the ordinary
income tax rate.
A more tax efficient alternative for higher income earners
MetLife Series B preferred stock
. Since it's actual preferred stock and not exchange traded debt,
this series pays income investors with dividends, not interest,
making the payments eligible for the qualified dividend tax rate
if all other requirements are also met (more on this later).
REIT preferred stock tax alert
Not all preferred stocks are eligible for the qualified dividend
tax rate however. Dividends from REIT preferred stocks do not get
the same tax benefits as dividends from most other companies.
One example can be found in
NorthStar Realty Finance Corp Series A preferred
. Although this is a type of preferred stock, it is not eligible
for the qualified dividend tax rate. When making income
investment decisions, it is important to take this into
Qualified dividend tax rate
Getting the qualified dividend tax rate requires more than just
picking the right investments. The IRS is very clear on what
other requirements are needed to obtain a lower tax rate.
Among them are holding period requirements (at least 60 days
prior for common stock and at least 90 days prior for preferred
stock) and that the dividends must be paid by either a U.S.
corporation or a qualifying foreign corporation. For more details
and examples of holding period situations and which corporations
qualify, the IRS section on qualified dividends actually does a
pretty good job explaining it.
Creating a tax efficient portfolio is essential to being able to
keep the most of your gains as possible. By reviewing the
differences between interest paying securities and dividend
paying securities, you can better adjust your portfolio for
Of course each situation is unique and you should always run
the numbers to see which income investment is really best for
you. After all, taxes are just one part of the equation when it
comes to investing.
Getting the most bang for your buck
One of the dirty secrets that few finance professionals will
openly admit is the fact that
as a group handily outperform their non-dividend paying
brethren. The reasons for this are too numerous to list here,
but you can rest assured that it's true. However, knowing this
is only half the battle. The other half is identifying which
dividend stocks in particular are the best. With this in mind,
our top analysts put together a
free list of nine high-yielding stocks
free list of nine high-yielding stocks that should be in every
income investor's portfolio. To learn the identity of these
stocks instantly and for free, all you have to do is
click here now
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has no position in any stocks mentioned.This article is not an
endorsement to buy or sell any security and does not constitute
professional investment advice. Always do your own due diligence
before buying or selling any security. He is not a tax
professional and you should always talk to a licensed tax
professional before making investment decisions. The Motley Fool
has no position in any of the stocks mentioned. Try any of our
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