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Invest far-and-wide for low-taxed dividends

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in Small Business Tax

Tax-astute investors can take advantage of special tax breaks for long-term capital gains and qualified dividends. For instance, if you invest in a U.S. company that pays current dividends, the IRS caps that maximum federal income-tax rate at just 15 percent.

But this tax break covers more than you might think.

Strategy: Spread your investments abroad. Reason: The preferential tax treatment extends to dividends received from “qualified foreign corporations.” Despite the common perception, the company doesn’t necessarily have to be homegrown.

You can still benefit taxwise if you diversify internationally. And Congress has expanded the list of countries eligible to pay out qualified dividends.

Here’s the whole story: Prior to 2003, the IRS taxed dividends at ordinary-income rates. But the Jobs and Growth Tax Relief Reconciliation Act of 2003 established a maximum tax rate of 15 percent for qualified dividends. (The tax rate is only 5 percent for taxpayers in the lower tax brackets, zero from 2008 through 2010.) By contrast, ordinary- income rates can reach as high as 35 percent.

What is a qualified foreign corporation? It can be any of the following:
  • A foreign corporation incorporated in a U.S. possession.

  • 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 U.S. securities market.
Note that the lower tax rates don’t extend to any foreign corporation treated as a passive foreign investment company.

Good news: The IRS recently updated the list of countries from which qualified foreign dividends may be paid. It now includes Sri Lanka, Barbados and Bangladesh. (IRS Notice 2006-101) Previously, the list featured 52 countries with eligible treaties. The new Notice did not remove any countries from the list.

Tip: The special tax treatment for dividends was originally scheduled to expire after 2008. But the Tax Increase Prevention and Reconciliation Act extended the lower tax rates through 2010. Expect Congress to keep this expiration date.

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