Putting together a dividend tax theory to match a buy-and-hold investment strategy is much complicated by shifting tax laws.
Types
If you have held a stock for 60 days, dividends paid from the profits of a domestic publicly traded company are “qualified” dividends and currently are taxed at a maximum 15 percent, which is lower than the marginal tax rate for most investors. All other dividends are “non-qualified” or “ordinary,” and they are taxed as ordinary income at the investment owner’s tax rate.
Sources
Qualified dividends come not only from the shares of publicly traded companies but also from stock-holding mutual funds. Non-qualified dividends come primarily from shares of Real Estate Investment Trusts (REITs) and mutual funds holding bonds or REITs in their portfolios. Dividends paid from mutual funds holding tax-free bonds are not factored in to the account owner’s adjusted gross income (AGI).
Significance
Because qualified dividends (as well as long-term capital gains) are taxed at a rate lower than most investors’ marginal rates, investments yielding qualified dividends are more suited to be held outside of tax-deferred plans, such as 401(k) or IRA accounts. This is also true of investments paying tax-free dividends.
Considerations
Any investments yielding non-qualified dividends are best held in a tax-deferred account so the taxes will be paid in retirement, when the owner is likely to have dropped into a lower marginal tax bracket.
Changes
Beginning in 2011, all dividends will be taxed as ordinary income for all taxpayers, which will remove any advantage of holding stocks in taxable accounts.
Reminder
Even if you reinvest your dividends from stocks or mutual funds, you still must pay taxes on the dividend the year it is paid, unless the investment is held in a tax-deferred or tax-protected account.
Source : ehow.com