CARL WATTS & ASSOCIATES

November 04, 2013

www.carlwatts.com
office@carlwatts.com
Washington DC
 tel/fax 202 350-9002
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If you receive interest or dividends on a 1099 form, you already know that they are considered taxable income. But is all income from interest and/or dividends taxable? IRS regulations regarding income from interest and dividends are very clear and, as usual, comprehensive.

Most interest that you either receive or is credited to your account and that can be withdrawn without penalty is taxable income and is taxed at your income tax bracket rate.


Examples of taxable interest are interest on bank accounts, money market accounts, certificates of deposit, and deposited insurance dividends.

Dividends paid on deposits or share accounts in cooperative banks, credit unions, domestic savings and loan institutions, federal savings and loan associations, and mutual savings banks are also considered taxable interest income.


For most types of interest income over $10, you should receive a Form 1099-INT from the payer of the interest. Even if you do not receive this form, it is still your responsibility to report the income on your tax return.


Interest income is reported on Schedule B. If your taxable interest is less than $1,500, you may report the interest directly on your Form 1040, Form 1040A, or Form 1040-EZ.

However, certain interest you may receive is not taxable income. Below are the exceptions.

Interest on insurance dividends left on deposit with the Department of Veterans Affairs, however, is not taxable.

Interest on Series EE and Series I U.S. Savings Bonds generally does not have to be reported until the bonds mature or are redeemed. Interest from these bonds issued after 1989 may be excluded from income if used to pay for qualified higher educational expenses during the year and other requirements are met for the Educational Savings Bond Program.

Excludable interest from redeemed U.S. savings bonds used to pay qualified higher education expenses is figured on Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989, and shown on Schedule B.

This interest income exclusion phases out at higher income levels.

Interest income from Treasury bills, notes and bonds is subject to federal income tax, but is exempt from all state and local income taxes.

However, interest on some bonds used to finance government operations and issued by a state, the District of Columbia, or a U.S. possession is not taxable at the federal level. Report the amount of any tax exempt interest received during the tax year. This is an information reporting requirement only, and does not convert tax exempt interest to taxable interest. Form 1099-INT, Interest Income, or a similar statement should be received from each payer of interest of $10 or more, showing the taxable or tax exempt interest to be reported.

If a bond, note, or other debt instrument was originally issued at a discount, part of the original issue discount may have to be included in income each year as interest.

Form 1099-OID, Original Issue Discount, or a similar statement should be received from each payer of taxable original issue discount of $10 or more, showing the amount to be reported.

Nominee interest is interest you receive on behalf of the real owner of the investment that produced interest income. You must report the amount of interest you received on Schedule B, but you will also report that the interest does not belong to you and you will not pay tax on the amount. You must give the real owner a Form 1099-INT and that person will pay tax on the interest income.

Frozen deposits are interest amounts that are accrued during the tax year but are not available for you to withdraw for either of these reasons: the financial institution is bankrupt or insolvent; the state in which the institution is located has placed limits on withdrawals due to other financial institutions becoming insolvent or bankrupt.


You do not report this type of interest until the funds become available to you.

Income from Interest &
Dividends
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Dividends are distributions of property a corporation pays you because you own stock in that corporation. Most dividends are paid in cash. However, dividends may be paid as stock of another corporation or any other property. You also may receive dividends through your interest in a partnership, an estate, a trust, a subchapter S corporation or from an association that is taxable as a corporation. A shareholder of a corporation may be deemed to receive a dividend if the corporation pays the debt of its shareholder, the shareholder receives services from the corporation, or the shareholder is allowed the use of the corporation's property. Additionally, a shareholder that provides services to a corporation may be deemed to receive a dividend if the corporation pays the shareholder service-provider in excess of what it would pay a third-party for the same services. A shareholder may also receive distributions such as additional stock or stock rights in the distributing corporation; such distributions may or may not qualify as dividends.

You should receive a Form 1099-DIV, Dividends and Distributions, from each payer for distributions of at least $10.00. Also, if you receive dividends through a partnership, an estate, a trust, or a subchapter S corporation, you should receive a Schedule K-1 from that entity indicating the amount of dividends taxable to you. You must report all taxable dividends even if you do not receive a Form 1099-DIV or Schedule K-1.

Dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of the corporation. Dividends can either be classified as ordinary or qualified.

Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates.

Qualified dividends are ordinary dividends meeting special requirements to qualify for the 0% or 15% maximum tax rate. All the following must be true:

  • Dividends must have been paid by a U.S. corporation or qualifying foreign corporation.
  • Holding period requirements were met:

You must have held the stock for 60 days during the 121-day period that begins 60 days before the ex-dividend date.

The ex-dividend date is the first day following the declaration the buyer will not receive the next dividend payment.


  • The dividends are not:
Capital gain distributions,
From a tax-exempt corporation,
From an employee stock ownership plan maintained by the paying corporation,
Payments that are in lieu of dividends,

Actually treated as interest income.


Which tax rate the dividends qualify for depends on what the regular tax rate on the dividends would be. This is determined by your tax rate on earned income.

  • Dividends qualify for the 0% rate (tax-free) if you fall within the 10% or 15% tax brackets.
  • Dividends qualify for the 15% rate if you fall within a higher tax bracket.

All in all, reporting income from interest and dividends may not seem complicated, nevertheless, help from a tax professional is always advisable in all your dealings with the IRS.