 Income tax 2022-2023. Dividend income. Let's do some wealth preservation with some tax preparation. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need then can be done on a YouTube page. We also include added resources such as excel practice problems pdf files and more like quick books backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it. Within our income tax equation we're still focused on line one that being income remembering that the first half of the income tax equation is in essence an income statement although an unusual one we've got the income up top then we have the equivalent of the expenses or deductions which are a little bit strange in terms of the comparison to a normal income statement to get us down to the equivalent of net income which in this case is taxable income. Our goal for taxes is flipped on its head it's basically the opposite in that we want the taxable income to be as low as possible therefore we want our income line to be as low as possible and our deduction lines the equivalent of the expenses to be as high as possible when we're thinking about our income lines then the question is do we have income is that income something that has to be included as taxable income on the tax return ideally we would like to have a situation where we have income actual income money's coming in but it's exempt for whatever reason for taxes so we wouldn't have to be paying taxes on it legally now we're talking about dividend income which adds another level of complexity because dividend income is investment income from the distribution of a corporation to an investor and the corporation itself is a taxable entity so when we take the dividend income there's this double tax type of situation which could lead to another kind of component another issue we're introduced here to which is another set of tax rates for a particular type of income in other words when we get down to the taxable income we've saw that we applied in the progressive tax system which is already complex in and of itself down here because of multiple rates could be applied to the one taxable income amount depending on how much income there is but now we also could have situations where we have types of incomes that are subject to a completely different set of progressive tax rates and that might be the case with the dividend income because of that situation of double taxation so let's keep that in mind as we're thinking about this the dividend income is usually going to be income that we're receiving from investment so we're investing we're receiving a return on the investments now remember you got to kind of keep separate your investments in your mind those that are under the umbrella of say an IRA or 401k plan which is where most people have their investments because the when you have money in there you usually have it into the stock market and whatnot and bonds but they're usually going to be in mutual funds and you have a tax deferral situation most of the time which we'll talk about at a later point in time and then you might have stocks and bonds that are not under the umbrella of the IRA or a 401k or a retirement type of plan and in that instance when you have a taxable event possibly you're going to be receiving dividends or interest or possibly you sell the stocks then you could have a taxable event at that point in time so that's the first thing to kind of keep in mind you could invest in an individual stock you could invest in mutual funds mutual funds might be a bunch of stocks that are kind of pooled together as the general concept we might talk about that more in future presentation when we get into iris and 401k type of investments and deferrals and you could then have those same kind of investments under the umbrella of something like an IRA or a 401k plan which could have different kind of tax implications for it but let's think about a situation where we don't have an IRA or a 401k plan we're just investing in stocks for a corporation and then the corporation is going to earn money when the corporation earns money the corporation is a taxable entity in and of itself so it's going to be paying taxes on the corporate level that's one of the the beauties of the corporation entity it was actually a fairly recent still invention to have a corporation and apply to the corporation attributes that are usually only applied to individuals such as it basically owning property and being able to pay tax and then they're going to pay the earnings from the corporation to the owners so here's us the owner over here and once again the iris is going to basically step in the middle of that transaction and take some of the money going there because now we're going to call it income to the individual so you can see this is why we have this double taxation situation the corporate entity in and of itself is going to be a taxable entity and so they have to pay taxes when they earn income on the corporate level and then they're giving that money to the owner of the corporation in the form of dividends and now we're calling that a taxable event income to the investor at that point now if you're a small business you can see you can clearly see that this would be something that would be annoying so if you're a small business for example and you're a sole proprietor and you were trying to get a corporation of some kind possibly for liability protection before they came up with some of these other entities like an like an s corp or an llc the option would be to be a c corporation and if you were just a sole proprietor that became a c corporation the structure would be quite annoying because you would say okay now i'm a corporation the corporation now has to file a separate tax return instead of a schedule c right and then they pay taxes to the government on the corporate level they already paid the taxes and then when i the owner of my corporation pull the money out not in the form of draws but in this case in the form of dividends because that's what it's called for a corporation which would have to be the owner i mean the management of the corporation the board would have to decide on the dividends but when the money comes out to the owner it would be taxed again and you could see that would be quite an annoying situation if you were thinking about running your business as like a small sole proprietor that became a c corporation that's why they came up with s corporations and llc's to try to avoid that double taxation while still having some of the liability protection and whatnot now for large corporations when you invest in like publicly traded companies like most people do usually through mutual funds and possibly using 401k plans and iris and whatnot retirement funds but when you invest into publicly traded companies the idea is that you are a passive investor you're not really actively involved in the day to day decision making although you still have the capacity possibly to vote for say the board of directors who would then be hiring the management to help make the decisions but usually with these very large publicly traded companies our our share in influence is so low that we're kind of passive investors which is one of the arguments that is used to say and justify this kind of double taxation issue but this is one of the debates that always is going to come into play in terms of should we be taxing in this double taxation way and is it beneficial to the stock market what if we taxed these dividends at ordinary income rates well that might lower the amount of money that people are willing to put into the stock market which could be bad for the economy and so on and so forth so this is one of the kind of areas that are debated oftentimes from a policy standpoint but you can see the general concept as to why the dividends might then be tried to tax at at least a lower rate possibly because of that double taxation okay so then we have the types of dividends we've got the ordinary dividends and the qualified dividends and we have to have this definition between the two because we might provide a preferential tax treatment to the dividends that are the qualified dividends so you might get a 1099 div this would be coming from the financial institutions possibly some of the same financial institutions that you get interest income from so you might have like a 1099 div and a 1099 INV coming from similar types of financial institutions and and it might not look exactly like this but the box names will basically be the same some of sometimes the financial institutions will format them however they want to format them the main two boxes are going to be box 1a and 1b box 1a is the total ordinary dividends box 1b is the qualified the portion of the dividends up top that are going to be the qualified dividends which might allow you to have some preferential tax treatment for them then we've got the total capital gain distributions this would be distributions that were not qualified as dividends but basically our capital gains instead of dividends possibly because they're not coming out of the retained earnings but but rather coming out of the of the corporate the investments that people have made into the stocks so then you'd have to pay taxes and that would possibly go to like a schedule D instead which we'll talk about later unrecaptured section 1250 so you've got some more of these lines which usually most softwares will help you to kind of populate these into the system if they're applicable section 1202 game collections section 879 ordinary dividends sections 879 capital gains non-dividend distributions federal income tax withheld now oftentimes you wouldn't be withholding from the dividend distributions for most people but if you're in retirement you might ask for withholdings in a similar way as your W2 withholdings and and use that as a form of payment but you'll see that a lot less common here than with distributions from a W2 or with distributions from like a retirement plan for example section 199 a dividends investment expenses foreign taxes so sometimes you're going to have some issues if they're investments in foreign countries where you got foreign taxes paid which most software will help you to kind of determine where to populate that and then cash liquidation distributions non-liquidation distributions exempt interest dividends special private activity and state information on down below okay so most of this information is going to be coming from the form 1040 instructions tax year 2022 line instructions so if we look on the first page of the form 1040 we're looking at the dividend income which is going to be the income down here qualified dividend and the ordinary dividend and if we look on the schedule b then we looked at interest last time up top now we'd be looking at the part two which would be the ordinary dividends we could pull in the page one of the form 1040 we'll see in a future presentation when we do the software example all right so line 3a qualified dividends enter your total qualified dividends online 3a qualified dividends are also included in the ordinary dividend total required to be shown online 3b qualified dividends are eligible for a lower tax rate than other ordinary income so it's a lower tax rate and again when we when you say okay it's a lower tax rate we can look at what that tax rate is but remember when you calculated in tax software you're usually dependent upon the software to do the calculation so you so you're not actually going to you might not see how it applied the tax tables and then this lower rate so you have to be able to kind of intuitively understand it possibly recalculate it with our excel worksheet we'll take a look at that in our example problem in our following presentation so generally these dividends are shown in box 1b of forms 1099 div c publication 550 for the definition of qualified dividends if you receive dividends not reported on form 1099 div exception some dividends may be reported as qualified dividends in box 1b of form 1099 div but aren't qualified dividends these include dividends you've received as a nominee c schedule b instructions to look at a situation similar to that when we when we saw it for the interest similar kind of scenario dividends you received on any share of stock that you held for less than 61 days during the 121 day period that began 60 days before the x dividend date the x dividend date is the first date following the declaration of a dividend on which the purchaser of a stock isn't entitled to receive the next dividend payment when continuing the number of days you held the stock when counting the number of days you held the stock include the day you disposed of the stock but not the day you acquire acquired a very tall stepladder it see the examples that follow also when counting the number of days you held the stock you can't count certain days during which your risk of loss was diminished c publication 550 for more details so usually you'd be okay to report what's on the form 1099 div but if you're like a day trader type of situation it's likely that you might have have some of these situations where you're buying and selling stocks on a shorter time frame which means you could run into situations or problems so dividends attributable to periods totaling more than 366 days that you received on any share of preferred stock held for less than 91 days during the 181 day period that began 90 days before the extended the extended the x dividend date when counting the number of days you held the stock you can't count certain days during which your risk of loss was diminished you can see publication 550 for more details so dividends on any share of stock to the extent that you are under an obligation but rather an obligation in including a short sale to make related payments with respect to positions in substantially similar or related property payments in lieu of dividends but only if you knew or have reason to know that the payments aren't qualified dividends dividends from a corporation that first became a surrogate being surrogate fathered a boy who's lost his own foreign corporation after december 22nd 2017 other than a foreign corporation that is treated as a domestic corporation under section 7874 b so again those are a little outside what the norm of normal day-to-day investors on the long-term perspective would be let's look at an example you bought 5000 shares of xyz corp corporation common stock on july 8th 2022 xyz corporation paid a cash dividend of 10 cents per share so notice how the the dividends basically work you can't like it's not like a partnership where the corporation can just pay off certain owners of the of the partnership according to the partnership agreement or to the draws of a particular partner they have to agree to pay all shareholders the same amount each share the same amount people will still get paid different amounts depending on how many shares they own so if you own more shares then you're going to get paid more because they're going to be paying out on a per share basis so the x dividend date was july 16 2022 your form 1099 div from xyz corporation shows $500 in box one a ordinary dividends and in box one b qualified dividends however you sold 5000 shares on august 11th 2022 you held your shares of xyz corporation for only 34 days so again this is why it's a little bit unusual for normal investors that aren't doing like day-to-day kind of trading because it's unlikely that you're going to hold a stock for such a short time frame for most people so only 34 days of 121 day period from july 9 2022 through august 11 2022 the 121 day period began on may 17 2022 60 days before the x dividend date and the end and ended on september 14 2022 you have no qualified dividends from xyz corporation because you held the xyz stock for less than 61 days let's do another example example number two the facts are the same in example one except that you bought the stock on july 15 2022 the day before the the x dividend date and you sold the stock on september 16 2022 you held the stock for 63 days from july 16 2022 through september 16 2022 the $500 of qualified dividends shown in box one b of form 1099 div are all qualified dividends because you held the stock for 61 days of the 121 day period from july 16 2022 through september 14 2022 just clears day obviously so example three you bought 10 000 shares of abc mutual fund common stock i just want to point out again again most people are investing in mutual funds oftentimes often under the umbrella of like an ira or a 401k plant so you're probably not going to run into these scenarios again unless you're purchasing like individual stocks and buying and selling them on the shorts so on the short term so you bought 10 000 shares of abc mutual fund common stock on july 8 2022 abc mutual fund paid cash dividend of 10 cents per since a share the x dividend date was july 16 2022 the abc mutual fund advises you that the part of the dividend eligible to be treated as qualified dividends equals two cents a share your form 1099 div from abc mutual fund shows total ordinary dividends of $1 000 and qualified dividends of $200 however you sold the 10 000 shares on august 11 2022 you have no qualified dividends from abc mutual fund because you held abc mutual fund stock for less than 61 days tip use the qualified dividends in capital gain tax worksheet or the schedule d tax worksheet whichever applies to figure your tax see the instructions for line 16 for details obviously software is useful and helpful in this situation as well line 3b ordinary dividends each pair should send send you a form 1099 div so that's going to be the financial institution given you your 1099 div that you're investing with enter your total ordinary dividends on line 3b this amount should be shown in box 1a of forms 1099 div you should fill in and attach schedule b if total is over 1500 or you received as a nominee ordinary dividends that are actually belong to someone else so we talked about that second situation in a similar fashion when we looked at the interest the basic idea the schedule b includes what we might think of as usually oftentimes passive types of income income from investments for example interest and dividends if the amount goes over 1500 then the iris wants you not only to report it on the first page of the form 1040 but also to include that schedule b so non-dividend distributions some distributions are a return of your cost or other basis they won't be taxed until you recover your cost or other basis you must reduce your cost or other basis by these distributions after you get back all of your costs or other basis you must report these distributions as capital gains on form 8949 for detail c publication 550 so when we think about a this is where you might see something on that 1099 div that is under like capital gain distributions because when when when something is distributed from the corporation as dividends it's coming out of what they call the retained earnings that's what we assume it's coming from so corporations kind of instead of having to differentiate their value based on say a partnership having different partnership capital accounts that represent kind of the ownership value in the corporation it's broken out in terms of the earnings that have been retained which haven't been distributed in the form of dividends and then the amount of the the value of the corporation that we're applying to the investments in the corporation from the original issuance of the shares when when they actually issued the shares from the corporation so so if the money's coming out of retained earnings then it's a normal dividend but if you're if you're saying well it's now dipping into not just the retained earnings but a return of the capital the owner's investment in the in the corporation through the original issuance of the stock that's when it might be something other than a dividend distribution kind of in theory and so then it might be a capital gain type of situation where you might have to think okay maybe I have to compare that to how much I paid into the distribution or possibly report it on schedule d in some way shape or form in a similar way as if I kind of like sold the stock right because they're actually giving me my value back they're dipping into the investment as opposed to the earnings of the corporation okay so tips so that that sounds kind of complicated by the way when I kind of talk it through this way but usually it's pretty straightforward to enter into the tax return because you'll be able to see a data input form for the gain distributions and you can put that in there and the tax software will will usually be able to calculate that you might have to report capital gains on it you want to be able to kind of explain that to some degree to yourself into a client as to why you have something in dividend distributions why they broke some of it out into these other boxes like a capital gain so tip dividends on insurance policies are a partial return of the premiums you paid don't report them as dividends include them in income on schedule one line eight z only if they exceed the total of all net premiums you paid for the contract so here's the gonna be the dividend rates here so notice we have different dividend rates if we qualify for the preferential ordinary dividends uh i'm sorry the qualified dividends and that usually happens if they're like a us uh entity corporation uh entity so then we might qualify and say okay now they're a qualified dividend if that is the case then we're gonna have these preferential rates so if we're single we're reading the table zero up to 41 675 the rates gonna be zero if we're single and we're 41 676 up to 459 750 of agi taxable income in essence uh our income then the agi adjusted gross income generally then we're at the 15 percent and that's usually going to be what they're trying to do is give a preferential tax rate compared to the ordinary income tax rate which is difficult to do because ordinary income is already on a on a on a progressive tax system with different tax rates so we're they're trying to say i'm trying to say or come up with a structure where these qualified dividends are going to be taxed at a lower rate but i can't just pick one rate because people are already being taxed at the progressive rate so it'll depend on what your ordinary income tax is basically on average to try to give you a more preferential tax rate for the qualified dividends right so if your income is higher than it would be at 20 percent which would be a good percent if they just put it at 20 percent then it would actually be a detriment to to lower income people to invest and generate dividends because their average tax rate it's not going to be 20 percent right so now they have to come with this kind of progressive tax system to try to get a more favorable rate so they can incentivize people investing generally in us corporate stocks and so on and the and the and the ride goes on obviously those thresholds change here so you might not kind of memorize this table but your general idea might be look if you have if you're investing and you have qualified dividends then you you might have a favorable rate in compared person to your ordinary income rates that's you know that's the point which will be calculated when you calculate the tax and now the tax is being calculated using a progressive tax system and this more favorable rate which is applied just to the income that is the qualified dividend income we'll dive into that a little bit more and how that actually might work with an example using tax software in a following presentation