While dividends from US ETFs are classified as capital gains or returns of capital for US taxpayers (those who file a US tax return), they are nevertheless fully taxable to Canadian taxpayers.
How can I know if the dividends from my ETFs are qualified?
Let’s start with the fact that ETFs that carry stocks typically pay dividends once a year, while ETFs that hold bonds often pay interest monthly. If you’re going to invest in an ETF that contains equities, make sure it pays eligible dividends.
An American corporation or a qualifying foreign company must pay qualified dividends. They must not have been reported to the IRS as a qualifying dividend, and the holding period must have been met.
To be eligible for a qualified dividend, you must own an ETF for at least 60 days prior to the dividend being paid. Qualified dividends are currently taxed at 0%, 15%, or 20%, depending on your filing status and tax bracket.
Why aren’t my ETF dividends tax deductible?
- Qualified dividends: These are dividends that the ETF has designated as qualified, which means they are eligible to be taxed at the capital gains rate, which is based on the investor’s MAGI and taxable income rate (0 percent , 15 percent or 20 percent ). These dividends are paid on stock held by the ETF for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date and ends 60 days after the ex-dividend date. Furthermore, throughout the 121-day period beginning 60 days before the ex-dividend date, the investor must own the shares in the ETF paying the dividend for more than 60 days. If you actively trade ETFs, you will almost certainly be unable to achieve this holding requirement.
- Nonqualified dividends: These dividends were not designated as qualified by the ETF because they were paid on stocks held by the ETF for less than 60 days. As a result, they are subject to ordinary income tax rates. Nonqualified dividends are calculated by subtracting the total dividends from any component of the total dividends that are classified as qualified dividends.
Note that while qualifying dividends are taxed at the same rate as capital gains, they cannot be used to offset losses in the stock market.
Are dividends from Vanguard ETFs tax deductible?
What are qualified dividends, and how do you get them? Dividends might be “qualified” for special tax treatment if they meet certain criteria. (Those who aren’t are referred to as “unqualified.”) Most payments from U.S. corporations’ common stock are eligible if you hold the shares for longer than 60 days.
What are the requirements for eligible dividends?
Regular dividends that meet particular criteria, as stated by the United States Internal Revenue Code, are taxed at the lower long-term capital gains tax rate rather than the higher tax rate for an individual’s ordinary income. Qualified dividend rates range from 0% to 23.8 percent. The Jobs and Growth Tax Relief Reconciliation Act of 2003 established the category of qualified dividend (as opposed to ordinary dividend); previously, there was no distinction and all dividends were either untaxed or taxed at the same rate.
The payee must own the shares for a sufficient period of time to qualify for the qualified dividend rate, which is usually 60 days for common stock and 90 days for preferred stock.
The dividend must also be paid by a corporation based in the United States or with particular ties to the United States to qualify for the qualifying dividend rate.
What is a qualified dividend, exactly?
Dividends from domestic firms and certain eligible foreign corporations that you have held for at least a defined minimum amount of time, known as a holding period, are considered qualified dividends. Another requirement is that the shares be unhedged, which means that during the holding period, no puts, calls, or short sales were associated with them.
The capital gains rate applies to these dividends, which is determined by the investor’s modified adjusted gross income (AGI) and taxable income (the rates are 0 percent , 15 percent , and 20 percent ). The 3.8 percent net investment income tax (NIIT) stipulated in the Affordable Care Act also affects higher earnings. On long-term capital gains and dividends, many people pay an effective rate of 18.8 percent (15 percent + 3.8 percent for the NIIT) or 23.8 percent (20 percent +3.8 percent).
Payments in lieu of dividends may be made in specific circumstances, such as when shares are lent to a third party. Learn more about Annual Credit for Substitute Payments if this applies to you.
Qualified dividends on your tax reporting statement
Qualified dividends are reported in line 1b or column 1b of Form 1099-DIV. However, it’s possible that not all of the dividends reported on those lines met the holding period requirement. Non-qualified dividends, like all ordinary dividends, may be taxed at your regular income tax rate, which can be as high as 37%.
Unless you hedged the assets, the potential eligible dividends reported on your Form 1099-DIV should fulfill the holding period requirement and qualify for the reduced tax rate if you did not buy or sell securities throughout the tax year.
Holding periods
Although the holding period requirement is the same whether you received a dividend for shares you own directly or through a mutual fund during the tax year, the method you use to calculate the holding period may differ, as shown below.
Note: When calculating the number of days the fund was held, include both the day it was obtained and the day it was sold.
Mutual funds
- The fund had to have held the security unhedged for at least 61 days out of the 121 days that started 60 days before the ex-dividend date. (The ex-dividend date is when the dividend is paid and processed, and any new buyers are eligible for future payments.)
- The security must be held for 91 days out of the 181-day period, beginning 90 days before the ex-dividend date, for specific preferred stock. The money obtained by the fund from that dividend-paying investment has to be delivered to you later.
- You must have held the fund’s applicable share for at least 61 days out of the 121-day period that began 60 days before the fund’s ex-dividend date.
Stock
- You must have held those shares of stock unhedged for at least 61 days out of the 121-day period beginning 60 days prior to the ex-dividend date.
- The securities must be held for 91 days out of the 181-day period beginning 90 days before the ex-dividend date for certain preferred stock.
Example of determining holding period
Consider the following scenario: you have dividends on Form 1099-DIV that are qualifying from shares in the XYZ fund. On April 27 of the tax year, you purchased 10,000 shares of the XYZ fund. You sold 2,000 of those shares on June 15, but you continue to own the remaining 8,000 shares (unhedged at all times). The XYZ fund’s ex-dividend date was May 2.
As a result, you held 2,000 shares for 49 days (from April 28 to June 15) and 8,000 shares for at least 61 days over the 121-day window (from April 28 through July 1).
Dividend income from 2,000 shares held for 49 days would not be considered qualifying dividend income. Dividend income from the 8,000 shares that have been held for at least 61 days should be considered qualifying dividend income.
Calculating the amount of qualified dividends
Find the portion per share of any qualified dividends once you’ve determined the number of shares that meet the holding period requirement. Multiply the two sums for each qualified dividend to get the actual qualified dividend amount.
To continue with the previous example, a $0.18 per share dividend was paid, but only half of it ($0.09 per share) was recorded as a qualifying dividend. Because you only held 8,000 of your total 10,000 shares for the requisite holding time, the amount of eligible qualified dividends is calculated as follows:
Only $900 of the $1,800 reported as ordinary dividends for the XYZ fund in line or column 1a of Form 1099-DIV would be reported as a Qualified Dividend in line or column 1b. Only $720 of that $900 should be taxable at one of the lower rates. The remaining $1,080 in dividends would be taxed at your regular rate of income tax.
Are REIT dividends tax deductible?
The majority of REIT distributions are classified as non-qualified dividends, meaning they are not eligible for the capital gains tax rate. In most circumstances, qualifying dividends are taxed at a 15% capital gains rate, whereas non-qualified dividends are taxed at the individual’s regular income tax rate.
What are the signs that a stock delivers a qualifying dividend?
To be eligible, you must own the stock for at least 60 days within the 121-day period beginning 60 days before the ex-dividend date. If that makes your head spin, consider this: If you’ve held the stock for a few months, you’re almost certainly getting the qualified rate.
Is the ETF dividend taxed?
ETF dividends are taxed based on the length of time the investor has owned the ETF. The payout is deemed a “qualified dividend” if the investor held the fund for more than 60 days before the dividend was paid, and it is taxed at a rate ranging from 0% to 20%, depending on the investor’s income tax rate. The dividend income is taxed at the investor’s ordinary income tax rate if the dividend was kept for less than 60 days before the payout was issued. This is comparable to how dividends from mutual funds are handled.