The preferential federal income tax treatment for qualified dividends (15% rate for most folks, 20% maximum rate for high-income individuals) is well known. But many taxpayers believe that the tax benefits are limited to dividends received from U.S. companies.
Strategy: Expand your investment horizons. This tax break also includes dividends received from qualified foreign corporations.
In other words, you can prosper tax-wise when you diversify internationally within your portfolio.
Here’s the whole story: Prior to 2003, dividends were taxed at ordinary, just like most other income items. However, the “Bush tax cuts” authorized a maximum tax rate of 15%. Later legislation increased the maximum rate to 20% for 2013 and beyond. Also, the tax rate on qualified dividends was reduced to 5% for taxpayers in the regular 10% and 15% tax brackets and was later reduced to 0% for individuals in those tax brackets.
In contrast, ordinary income tax rates now reach as high as 39.6%. Finally, the reduced tax rates for qualified dividends were made permanent by the American Taxpayer Relief Act of 2012 (ATRA).
What is a “qualified foreign corporation” for this purpose? It can be any of the following:
- A foreign corporation in a possession of the United States.
- A foreign corporation eligible for the benefits of a U.S. income tax treaty that the IRS determines to be satisfactory and that includes an exchange of information program.
- A foreign corporation if the stock paying the dividend is readily tradeable on an established securities market in the United States.
Note, however, that the lower rates for dividends do not extend to any foreign corporation treated as a passive foreign investment company.
Online resource: The IRS periodically updates the list of countries from which qualified foreign dividends may be paid. See IRS Pub. 17, Your Federal Income Tax.