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Map out your tax break for foreign dividends

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in Small Business Tax,Small Business Tax Deduction Strategies

The new 2010 Tax Relief Act preserves favorable tax treatment for qualified dividends through 2012. Thus, you can benefit from a low tax rate for the dividends you receive from most domestic companies.

Strategy: Expand your investment horizons. This tax break also includes dividends received from “qualified foreign corporations.” Despite the common perception, the issuing company doesn’t have to be homegrown.

In other words, you can benefit tax-wise while you diversify internationally within your portfolio.

Here’s the whole story: Prior to 2003, dividends were taxed at ordinary income tax rates. But the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) established a maximum tax rate of 15% for most investors. Also, the tax rate was lowered to 5% for taxpayers in the regular 10% and 15% tax brackets.

These tax breaks were subsequently extended through 2010. What’s more, the 5% tax rate for lower-income taxpayers was reduced to 0%. In contrast, ordinary income rates can reach 35%.

What is a qualified foreign corporation? It may be any of the following:

  • A foreign corporation incorporated 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 tradable on an established securities market in the United States.

Note, however, that the lower tax rates do not extend to any foreign corporation treated as a passive foreign investment company.

Tip: The IRS periodically updates the list of countries from which qualified foreign dividends may be paid. (See the list in IRS Pub. 17, Your Federal Income Tax.)

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