What exactly are dividends?

What is the difference in tax rates between qualified dividends & non qualified?

• **My account at Fidelity is taxable** I have money in a Fidelity mutual fund called "cash reserves" The yield is 5.00% But the dividends this fund pays do not qualify for the lower tax rate I own shares in Bank Of America, this yields 5.30% but the dividends qualify for the lower rate. I'm guessing Bush enacted these cuts to give people an incentive to keep money in stocks rather than money markets (cash). I'd really appreciate it if someone could give me the actual differences. Thanks in advance

• Answer:

  Ordinary dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of the corporation. Ordinary dividends are taxable as ordinary income unless they are qualified dividends. Qualified dividends are ordinary dividends that meet the requirements to be taxed at the same maximum rates as net capital gains. Qualified Dividends Dividends eligible for the special tax rate are those received from domestic corporations and certain qualifying foreign corporations whose stock is traded on a U.S. securities exchange or other established market. The 2003 Act did not define "dividend." However, a dividend is generally a corporate distribution to shareholders, based on their stock holdings, made out of current or accumulated earnings and profits, unless the distribution is specifically treated as a non-dividend by tax law (e.g., as a redemption or liquidation distribution). Dividends that pass through to individuals from regulated investment companies may be eligible for the reduced tax rate on dividends. Mutual fund dividends will be eligible only to the extent they represent dividends the mutual fund earned on stock, and not on other types of fund earnings such as interest. Mutual funds will report to individual investors the portion of their dividends eligible for the reduced rates. Ineligible Dividends The special tax rates do NOT apply to dividends paid by, among other things: Mutual insurance companies; Credit unions, mutual savings banks, savings and loans, and certain other types of financial institutions; Nonprofit voluntary employee beneficiary associations (VEBAs); Employer securities owned by an employee stock ownership plan ( ESOP) to the extent the dividends are deductible under IRC Sec. 404(k); Stock purchased with borrowed funds when the dividend was included in investment income for purposes of claiming an investment interest deduction; Tax-exempt corporations under IRC Sections 501 or 521; Farmers’ cooperatives; Foreign personal holding companies; Foreign investment companies; Passive foreign investment companies; and Stock owned for 60 days or less in the 120-day period beginning 60 days before the ex-dividend date (when the corporation makes final the shareholders who will receive the dividend). The special tax rates also do NOT apply to: Payments received in lieu of dividends when shares are loaned out (this may occur when shares are held in an account with a margin agreement); Dividends received in an IRA or qualified retirement plan; or Any dividend to the extent the taxpayer is under an obligation to make related payments with respect to positions in substantially similar or related property. It appears that dividends on preferred stock will NOT be eligible for the special tax rate if the issuing corporation follows the common practice of (1) treating the preferred stock as debt on its books, and (2) deducting the "dividends" on such stock as interest. Effective Date and Sunset The special tax rates apply to qualified dividends received on and after Jan. 1. 2003, and through Dec. 31, 2010. For individuals in the 15% or lower tax bracket, a zero-percent rate will apply to qualified dividends received in years 2008 - 2010. The special rates are scheduled to expire for dividends received after 2010. Note, these special rates were extended under the Tax Increase Prevention and Reconciliation Act of 2005.