Hello chicagorunner-ga,
Whether your preferred stock will be taxed at the lower rate or not
under the new tax law will depend on what type of preferred stock you
own.
Unfortunately, it appears that most preferred stock dividends will not
qualify for the lower rate because they considered interest rather
than dividends. Only traditional preferred stock dividends, on which
the company has already paid taxes, will qualify.
According to a USA Today article on the subject titled, “Most
preferred stock wouldn't get tax help”
http://www.usatoday.com/money/perfi/taxes/2003-01-09-dividends-cover-preferred_x.htm
“Nearly 75% of so-called preferred shares are actually a popular
hybrid Wall Street came up with to appease corporations in the 1990s.
These shares, called hybrid preferreds, are treated as debt and give
companies a tax break.
There's no potential tax break for individual investors, though,
because payments made by companies on hybrid preferred shares are
considered interest, not dividends, and are not included in Bush's
plans. Making things worse, the only way investors can tell what kind
of preferred stock they have or are buying is by diving into the
prospectus.”
---
“Preferred shares that stand to benefit from Bush's proposal are very
rare. Only about 100 companies, mostly banks and utilities, have $24
billion worth of traditional preferred stock outstanding. Those scarce
issues are the only ones paying dividends that would qualify for a
break, says William Scapell, director at Merrill Lynch. That's dwarfed
by the $140 billion worth of hybrid preferred shares that pay interest
and wouldn't be eligible.
Investors should think twice before trying to snap up the traditional
preferred. Most were issued in the 1950s and aren't actively traded.
They often don't even have ticker symbols, making them difficult to
buy or sell. Also, they usually pay lower yields than hybrids, Scapell
says.”
According to Time.com
http://www.time.com/time/globalbusiness/article/0,9171,1101021223-400001,00.html
“That could change as early as next year. Lawmakers appear eager to
reduce or eliminate the tax on dividends from common stock, and they
may do the same for dividends from convertible and traditional
preferred stock as well — though not for dividends from the new breed
of fully taxable preferred. That prospect is driving up the prices of
dividend-paying stocks.
Why aren't fully taxable preferreds in line for tax relief? They have
so many bondlike traits that tax authorities treat the payouts not as
dividends but as interest payments (where no tax changes are in
store). So tax relief — if it ever comes — could tilt the table toward
traditional preferred. As for convertible preferred, that should be
thought of as common stock, which isn't the best way to generate an
income stream.”
According to BusinessWeekOnline
http://www.businessweek.com/bwdaily/dnflash/may2003/nf20030530_8758_db035.htm
“At first blush, preferred stocks -- shares that pay a high, fixed
dividend -- would also appear to get a big boost. But two-thirds of
the $208 billion market in preferred shares won't qualify for the tax
break on dividends, because their payout is more akin to interest than
to corporate dividends. While some experts predict a flood of new
preferred issues to take advantage of the tax cut, they also advise
investors to steer clear for now. "Preferred-stock mutual funds will
spring up to help investors sort out the accounting and get
diversification," says Martin Nissenbaum, director of personal finance
and taxes at Ernst & Young International.”
Other references:
Sunspot.net
http://www.sunspot.net/news/nationworld/bal-investors0523,0,7857636.story?coll=bal-home-headlines
“Q: Would all stock dividends be eligible for the lower rate?
A: No. Real estate investment trust dividends would not qualify for
the 15% rate, because most REITs don't pay corporate income taxes.
REIT dividends would be taxed at ordinary income tax rates, according
to the National Assn. of REITs.
Also, so-called preferred stocks may not qualify, depending on how the
securities are structured, tax experts say. If the income generated by
a preferred stock is considered to be interest rather than a dividend,
it would be subject to ordinary tax rates, experts say.”
San Francisco Chronicle
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2003/05/25/BU228791.DTL
“Preferred stocks -- If the preferred stock is an equity, the dividend
will qualify for the 15 percent tax. If the preferred stock is really
a debt instrument, which many are, the dividend is really interest and
will still be taxed as ordinary income, according to the U.S.
Treasury.”
Wayne State University Law School
http://www.law.wayne.edu/mcintyre/text/dividend_relief_details.pdf
“Wall Street has devoted a lot of effort in recent years to creating
hybrid securities that would look like preferred stock on corporate
balance sheets and thereby make the company appear to have more
equity, but whose payments would qualify as tax-deductible interest
payments for the company.
In fact, said William Scapell, a fixed-income analyst at Merrill
Lynch, 72 percent of the existing securities that are called preferred
stock fall into that category. Ms. Olson said that since companies
were deducting interest on the payments, the dividends would not be
tax free.
Another 13 percent of preferred issues either come from foreign
companies or from real estate investment trusts, and would not be
eligible for tax-free status.
Only the remaining 15 percent of existing preferred stock is eligible
for tax-exempt dividend payments. But Mr. Scapell said that some
companies might choose to redeem existing hybrid securities and issue
new preferred shares that would qualify for tax-exempt dividend
payments.”
TaxSavvyInvesting.com
http://www.taxsavvyinvesting.com/Taxsavvyinvesting24746PM/Articles/2003taxproposal.pdf
“Preferreds – the world turned upside down: At the first pass, it
would appear that preferred stocks, which traditionally pay large
dividends, would benefit greatly from this proposal. Well, to quote
our musical friend Mr. Gershwin, “it ain’t necessarily so”. That is
because there are many flavors of preferred stock, and among them is a
creation called Trust Preferreds. These are preferreds structured to
enable the issuer to treat them as debt. Accordingly, corporate tax
deductions are allowed for the dividends/interest paid thereon. When
they first emerged in the ’80s and ’90s the issuers loved them.
In fact they issued trust preferreds to refinance their conventional
preferreds and their common stock.
So what’s the problem here? Do you recall that the original objective
of the tax proposal was to eliminate double taxation? Well, the first
corollary to that objective is that those who got deductions do not
get to issue tax-free dividends. Otherwise the income would never be
taxed at all! So, under the new rules, the conventional preferreds
that had been in disfavor will be in demand, while the trust
preferreds that had been so popular will go out of favor.”
LazyInvestor.net
http://www.lazyinvestor.net/sample.htm
“Not all dividends will be exempt from taxes under the plan. In order
to qualify as a tax-free dividend, a company will have had to pay
taxes on those dividends. Thus, for “pass-through” entities that don’t
pay taxes at the corporate level, individuals receiving distributions
will still have to pay taxes on those distributions. For example,
distributions paid by real-estate investment trusts won’t be eligible
for a dividend exclusion. For that reason, it would not be surprising
to see REITs see some selling pressure if the president’s plan becomes
law. However, holding a few quality REITs in a portfolio makes sense
from a portfolio diversification perspective. Thus, as long as REITs
don’t make up more than, say, 5% to 7% of a portfolio, hold on to
them.
Other “dividends” that won’t get preferential tax treatment are those
paid by “trust preferred” securities. Yes, traditional preferred stock
will receive the tax exclusion on dividends. But preferred securities
going by such goofy-sounding acronyms as QUIPS (Quarterly Income
Preferred Securities) and TRUPS (Trust Preferred Securities) will not
receive the tax exclusion. That’s because these securities are nothing
more than debt disguised as preferreds. And the “dividends” paid by
trust preferred securities are considered interest income for tax
purposes.”
United States Department of the Treasury
Reduction in Individual Tax Rates on dividends and Capital Gains under
the Jobs and Growth Tax Relief Reconciliation Act of 2003
http://www.ustreas.gov/press/releases/js414.htm
I hope you have found this information helpful. If you have any
questions, please request clarification prior to rating the answer.
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