Preferred Stocks with Qualified Distributions

Almost everyone tries to minimize income taxes that they pay and for those investing outside a retirement plan one of the best ways to keep taxes down on income is to own income producing securities in which the dividends are ‘Qualified Dividends‘.

Since 2003 certain dividends have been subject to the same tax rate as long term capital gains instead of being taxed as ordinary income.  Remember that just because the dividends are ‘qualified’ dividends it doesn’t mean that all dividends you receive on your shares will be qualified for you.

For you to be able to claim them as qualified you must have held the shares for the required ‘holding period‘.  This would mean you must hold the shares at least 90 days including the ex-dividend date.  For a very long term holder this is no issue–for those that trade in and out of shares it may be a glitch.

Additionally one should remember that Qualified Dividends are only paid by a company that has taxable income—otherwise you officially are receiving a Non Dividend Distribution – likely to be classified as return of capital (ROC).  This ROC is subtracted from your cost basis and likely in the future you will have a capital gain on the sale of the security.  NOTE that just because you may have a capital gain does NOT mean you will owe taxes.  Those in the lower tax brackets may well pay NO taxes on the sale.

Because of the above even though the prospectus says it will pay Qualified Dividends–they may not be because they may have no taxable income.

Of course the largest area of preferred stocks is financials and these shares are ‘Qualified Dividends’.

Additionally investors sometimes refer to Exchange Traded Debt issues as preferred stock (which they are not of course)–they are debt and interest payments received on debt are taxed at ordinary tax rates.  The same goes for all dividends of Trust Preferred shares–they are essentially interest and not eligible for special tax treatment–they are NOT qualified dividends.

Lastly preferred stock dividends of Business Development Companies ARE NOT qualified distributions.  Like REITs if a tax benefit is realized at the company level (no taxes to be paid) there seldom is another tax benefit for the preferred holder.

We have identified some of the issues below that likely are Return of Capital issues as they are not making taxable income and we have colored the security description box RED.  NOTE that this can change as profitabililty changes.

FOR A QUICK SCAN ON ISSUES FALLING MORE THAN $1.00/SHARE JUST LOOK FOR BLUE IN THE ‘CHANGE’ COLUMN