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Making Sense of the Dividend-Tax Cut

Real Estate Investment Trusts (REITs)

By definition, REITs do not pay corporate tax on their profits, and they must pass on 90% of their net earnings to investors as dividends. Because of this structure, though, REIT investors will not be eligible for the 15% tax rate on REIT dividends. Instead, this income will continue to be taxed at the ordinary income tax rate.

But of course, there are a few exceptions. If the REIT pays a tax on all or part of its profits, its dividend (or a pro-rated portion of it) will be eligible for the 15% rate once it's distributed to investors. Also, if the REIT has taxable subsidiaries that contribute to the dividend payout, that portion will be eligible for the 15% rate as well. And if any part of the REIT dividend is attributable to capital gains the REIT incurred, that portion will be eligible for the 15% tax.

Foreign Stocks

Generally, if a foreign stock is traded as an ADR on a U.S. exchange, it will be eligible for the 15% dividend-tax rate. The reduced rate, though, will not apply to dividends paid by foreign investment companies, passive foreign investment companies or foreign holding companies. But some investors in non-ADR foreign stocks may still qualify for the 15% rate. Foreign companies based in U.S. territories (such as Puerto Rico or Guam) will be eligible, as will companies based in countries with favorable tax treaties with the U.S.

Investors in foreign stock mutual funds will receive an accounting from the fund company of which portion of their fund's dividend payments are subject to the 15% rate and which will still be subject to their ordinary income tax rate.

Also, if an investor pays foreign tax on the dividends received (unlikely if it's from an ADR) and subsequently receives a foreign tax credit for the amount of tax paid, the amount of credit allowed will be adjusted to reflect the new U.S. rates.

Retirement Plans

And don't forget that all stocks and funds, even dividend-paying ones, held in tax-advantaged accounts are ineligible for the reduced rate. Because you avoided tax on the money you contributed to such plans and then enjoyed the benefit of tax-deferred compounding, you don't get any additional tax breaks now. Instead, all your withdrawals from a 401(k) plan, a rollover IRA or a traditional deductible IRA will be taxed at your ordinary income tax rate.
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