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NEW LAW TIP: WATCH YOUR HOLDING PERIODS FOR DIVIDENDS

September 08, 2003

The 2003 Tax Act lowered the top rate for dividends to 15%, effective starting January 1, 2003. One feature of the new law will cost active traders the benefit of this lower rate.

The new law denies the lower rate for stocks that have not been held for over 60 days of the 120-day period beginning 60 days before the ex-dividend date of the stock. For preferred stock, the holding period is 90 days in a 180-day period.

EXAMPLE: Sally Shortterm buys 100 shares of Endrun company on December 20 , 2003 for $100. Endrun goes ex-dividend on December 21 with a $2 per share distribution, which is paid December 23. Sally sells the stock on December 24 for $98. The $2,000 dividend will not be eligible for the 15% top rate; it will instead be taxed at Sally's ordinary income rates, up to 35%.

Why? The value of a stock includes anticipated dividends. All else being equal, the value of a stock goes down by the amount of the dividend on the day the stock goes ex-dividend (the person who holds the stock when it goes ex-dividend received the dividend, even if she sells the stock before the dividend is paid). The 60-day rule discourages a taxpayer from attempting to get a 15% dividend at the cost of a short-term loss on the sale. Short term losses provide a tax benefit at ordinary rates (to 35%) to the extent of short-term gains, plus $3,000.

Without the 60-day rule, Sally would pay $300 in tax on her $2,000 dividend while reducing her taxes by $700 with her $2,000 short-term capital loss.

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