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Mutual Fund Dividend Trivia [qualified vs non-qualified]

Posted: Thu Nov 30, 2017 11:58 am
by Norton750
I recently learned that you can transform qualified dividends paid from a mutual fund into non-qualified dividends if your holding period for the fund is too short. At the federal level, qualified dividends are taxed at the (lower) capital gains rate and non-qualified dividends at the (higher) ordinary income rate, so this is not a desirable outcome – at least not in a taxable account.

Basically, if you receive a qualified dividend from a mutual fund but you do not hold the shares of that fund for the required 61 days, then those dividends become non-qualified, despite the fact that your 1099-DIV will report them as qualified.

Here’s an example from IRS Pub 550 https://www.irs.gov/publications/p550:
You bought 10,000 shares of ABC Mutual Fund common stock on July 5, 2016. ABC Mutual Fund paid a cash dividend of 10 cents per share. The ex-dividend date was July 12, 2016. The ABC Mutual Fund advises you that the portion of the dividend eligible to be treated as qualified dividends equals 2 cents per 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 8, 2016. You have no qualified dividends from ABC Mutual Fund because you held the ABC Mutual Fund stock for less than 61 days.
This means that a mutual fund that owns a stock that pays a dividend to the fund must meet the 61-day test for its holding period of the stock. At that point, the fund has received a qualified dividend that it will pass on to the shareholders as a qualified dividend. (I understood that much before) But the shareholders must also meet the 61-day holding period for the mutual fund shares - or else the dividend becomes non-qualified. This latter part was news to me.

So my questions to the group:
1. Have you heard of this rule?
2. Is this something you pay attention to when doing taxes? (Yes, I know - buy-and-hold mostly gets you around this being a concern)

Nick

Re: Mutual Fund Dividend Trivia

Posted: Thu Nov 30, 2017 12:04 pm
by alex_686
Yes, but then again I programmed systems to calculate QDI / DRD for mutual fund payouts. There are a few more wrinkles. Dividends can be non-qualified for many reasons. REITs kick off most non-qualified dividends, but a small portion of their dividends are qualified and other companies can kick off non-qualified dividends as well. Holding Period. International. The list goes on.

Not much you can do. Buy and hold. Certain asset classes - once again think REITs - are less efficient than others.

Re: Mutual Fund Dividend Trivia

Posted: Thu Nov 30, 2017 12:07 pm
by kd2008
1. Oh yes! If you have TLHed on the pastthen you know this will come into the picture for sure. There are many threads that discussed this in the past.

2. Yes, I pay attention to it simply because I have a record of all transactions and look at it before making TLH transactions. Before making TLH decisions, one ought to pay attention to this rule.

Re: Mutual Fund Dividend Trivia [qualified vs non-qualified]

Posted: Thu Nov 30, 2017 12:47 pm
by livesoft
1. Yes, discussed many times on that great forum bogleheads.org. You can probably search on the number "61" or "61 days" or "dividends 61-day" or "personal holding period." This real is also explained on in the IRS tax forms AND in the insert that comes with your brokerage 1099-DIV including the one from Vanguard. "61 days" has more than 1000 hits.

2. Of course. The "TLH documented" thread shows how this affected me and how I made the calculations and filled out my tax return to account for the difference.