706 / What is qualified dividend income?

Certain dividends are taxed as “net capital gain” for purposes of the reduction in the tax rates on dividends. “Net capital gain” for this purpose means net capital gain increased by “qualified dividend income” (without regard to this paragraph).¹ “Qualified dividend income” means dividends received during the taxable year from domestic corporations and “qualified foreign corporations” (defined below).²

The term qualified dividend income does not include the following:

(1) dividends paid by tax-exempt corporations;

(2) any amount allowed as a deduction under IRC Section 591 (relating to the deduction for dividends paid by mutual savings banks, etc.);

(3) dividends paid on certain employer securities as described in IRC Section 404(k);

(4) any dividend on a share (or shares) of stock that the shareholder has not held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date (as measured under IRC Section 246(c)). For preferred stock, the holding period is more than 90 days during the 181-day period beginning 90 days before the ex-dividend date if the dividends are attributable to a period exceeding 366 days (note, however, that if the preferred dividends are attributable to a period totaling less than 367 days, the holding period stated in the preceding sentence applies).³

Special rules. Qualified dividend income does not include any amount that the taxpayer takes into account as investment income under IRC Section 163(d)(4)(B).⁴ If an individual, trust, or estate receives qualified dividend income from one or more dividends that are “extraordinary dividends” (within the meaning of IRC Section 1059(c)), any loss on the sale or exchange of such share(s) of stock will, to the extent of such dividends, be treated as long-term capital loss.⁵

A dividend received from a mutual fund or REIT is subject to the limitations under IRC Sections 854 and 857.⁶ For the treatment of mutual fund dividends and REIT dividends under JGTRRA 2003, see Q 7937 and Q 7976, respectively.

Pass-through entities. In the case of partnerships, S corporations, common trust funds, trusts, and estates, the rule that qualified dividends are taxable as capital gains applies to taxable years ending after December 31, 2002, except that dividends received by the entity prior to January 1, 2003 are not treated as qualified dividend income.⁷

Qualified foreign corporations. The term “qualified foreign corporation” means a foreign corporation incorporated in a possession of the United States, or a corporation that is eligible for benefits of a comprehensive income tax treaty with the United States. If a foreign corporation does not satisfy either of these requirements, it will nevertheless be treated as such with respect to any dividends paid by that corporation if its stock (or ADRs with respect to such stock) is readily tradable on an established securities market in the United States.⁸

Common stock (or an ADR in respect of such stock) is considered “readily tradable on an established securities market in the United States” if it is listed on a national securities exchange that is registered under Section 6 of the Securities Exchange Act of 1934 (15 USC 78(f)), or on the NASDAQ Stock Market.⁹ As stated by the SEC, registered national exchanges include the following:

• 
  

  24X Exchange, LLC

  
  


• 
  

  NYSE American LLC (formerly NYSE MKT LLC, NYSE AMEX and the American Stock Exchange)

  
  


• Cboe BZX Exchange, Inc. (formerly BATS BZX Exchange, Inc.)


• Cboe BYX Exchange, Inc. (formerly BATS BYX Exchange, Inc.)


• BOX Exchange LLC (formerly BOX Options Exchange LLC)


• NASDAQ BX, Inc. (formerly the Boston Stock Exchange)


• Cboe C2 Exchange, Inc.


• Cboe Exchange, Inc.


• 
  

  NYSE Texas, Inc. (formerly NYSE Chicago, Inc, Chicago Stock Exchange, Inc.)

  
  


• Cboe EDGA Exchange, Inc. (formerly BATS EDGA Exchange, Inc.)


• Cboe EDGX Exchange, Inc. (formerly BATS EDGX Exchange, Inc.)


• 
  

  Green Impact Exchange, LLC

  
  


• Nasdaq ISE, LLC (formerly International Securities Exchange, LLC)


• Investors Exchange, LLC


• Long-Term Stock Exchange, Inc.


• MEMX, LLC


• 
  

  MX2 LLC

  
  


• Nasdaq GEMX, LLC (formerly ISE Gemini)


• Nasdaq MRX, LLC (formerly ISE Mercury)


• Miami International Securities Exchange, LLC


• MIAX PEARL, LLC


• MIAX Sapphire, LLC


• MIAX EMERALD, LLC


• The Nasdaq Stock Market LLC


• NYSE National, Inc. (formerly National Stock Exchange, Inc.)


• NYSE American LLC (formerly NYSE MKT)


• New York Stock Exchange LLC


• NYSE Arca, Inc.


• NASDAQ PHLX, LLC. (formerly NASDAQ OMX PHLX)¹⁰

In order to meet the “treaty test,” the foreign corporation must be eligible for benefits of a comprehensive income tax treaty with the United States that the Treasury Secretary determines is satisfactory for these purposes, and the treaty must also provide for the exchange of tax information. For the current list of tax treaties meeting these requirements, see Notice 2011-64.¹¹

The term “qualified foreign corporation” does not include any foreign corporation if, for the taxable year of the corporation in which the dividend was paid (or the preceding taxable year), the corporation is a passive foreign investment company (as defined in section 1297).¹²

Special rules apply in determining a taxpayer’s foreign tax credit limitation under IRC Section 904 in the case of qualified dividend income. For these purposes, rules similar to the rules of IRC Section 904(b)(2)(B) (concerning adjustments to the foreign tax credit limitation to reflect any capital gain rate differential) will apply to any qualified dividend income.¹³

For information reporting and other guidance on foreign stock dividends, see Notice 2006-3;¹⁴
Notice 2004-71;¹⁵ and Notice 2003-79.¹⁶