Unit 5: Interest and Dividend Income

Interest income

A form of income earned from deposits, notes receivable, and investments in instruments such as bonds. Some interest income is taxable and some is not. Dividends (including dividends on deposits or share accounts in coops, credits unions, domestic SLAs, and mutual savings banks) are actually reported as taxable interest income Interest income reported on Form 1099-INT. If the form was not received, the taxpayer is still responsible for paying the taxes If interest income exceeds $1,500, 1040EZ cannot be filed and the interest must be reported on Schedule B, and 1040 or 1040A must be used.

DRIPs:

allows a taxpayer to use dividends to purchase more shares of stock instead of receiving cash. Dividends must still be reported as income. If the plan allows for purchase at less than FMV, the FMV of the additional stock is reported as income

Stock dividends:

distribution of stock, rather than cash. Generally not a taxable event and does not affect the income in year of distribution. Instead, the basis of the individual shares is adjusted accordingly by the inclusion of new shares. If a shareholder as the option to receive stock or cash, the dividend is taxable in the year received.

Dividend income

A distribution of cash, stock or other property from a corporation or mutual fund; payer will generally use Form 1099-DIV to report to taxpayers. Like interest, dividend income of over $1500 must be reported on Schedule B, otherwise directly on form 1040 or 1040A. Not subject to employment taxes. Ordinary dividends: corporate distributions to shareholders of cash. Unless qualified, taxed as ordinary income rather than as capital gains. Reported on Box 1a of 1099-DIV Nondividend distributions: not paid out of earnings and profits. Considered a return of capital and are not taxable, but do reduce the taxpayer's basis. Once basis is reduced to zero, any additional are capital gains and taxed accordingly Qualified dividends: reported on box 1b of 1099-DIV. Given preferred tax treatment as capital gains if specific criteria are met. Minimum tax is: -1% on any amount otherwise taxed at 15% or less -15% on any amount otherwise taxed at >15% but <39.6% -20% on any amount otherwise taxed at 39.6% rate To qualify: -must have been paid by a US or qualified foreign corporation -taxpayer must have held the stock for more than 60 days during the 121-day period that begins 60 days before ex-dividend date (date following the declaration). To count, include day of disposal.

Tax-exempt interest

State and local government debt interest is generally exempt from federal income tax but may be subject to state and local taxes. If the debt is federally guaranteed, the interest is taxable. Taxpayer may still be subject to capital gains when the investment is sold. Line 8b of Form 1040 reports tax-exempt interest. It is used to calculate the taxability of certain income items, such as SS benefits.

CD interest

CD interest is generally taxable when received. If a taxpayer borrows money to open a CD, the interest paid on the loan is deductible up to the amount of net investment income

Gift for opening a bank account

Deposits < $5K: gift >$10 reportable Deposits >$5K: gift >$20 reportable Cash bonuses, reward points, airline miles, are all taxable. Cash back and reward points from credit card purchases are not taxable

Interest on US T-bills, notes, and bonds

Interest is taxable for federal income tax purposes Series EE bond is the most common type of bond; they are issued at a discount and the difference between purchase price and redemption price is the interest earned. Series I bonds are issued at face value with a maturity period of 30 years. Face value and accrued interest are payable at maturity. Individual taxpayers can report interest from these either when the bond matures or is redeemed, or each year as the bond's redemption value increases.But the same reporting method must be used for all EE and I bonds. When a taxpayer redeems, he should receive 1099INT Series HH are issued at face value, interest is paid twice a year and the interest is reported as it is paid

Mutual fund distributions:

Reported on 1099-DIV; reported based on character of the income source and may include ordinary dividends, qualified dividends, capital gain distributions, exempt-interest dividends, and nondividend distributions. Cap gains distributions are always long-term for a mutual fund, regardless of holding period. Distributions from a mutual fund investing in tax-exempt securities are tax-exempt interest and retain their tax-exempt character for the payee. But they still must be reported. If a mutual fund or REIT declares a dividend payable in Oct, Nov, or Dec but actually pays in Jan, the shareholder is deemed to have received the dividend in December and must report it.

Interest on education savings bonds

Series EE and I bonds can be used on a tax-free basis to pay qualified higher education expenses for a taxpayer, spouse, or dependents for whom an exemption is claimed. 2014 exclusion MAGI phaseout for MFJ or QW taxpayers between $113,950 and $143,950. MFS taxpayers are not entitled to the exclusion. S or HOH phaseout is $76,000 and $91,000. Exclusion is calculated on Form 8815 - bonds must be purchased by the owner, not a gift, qualified expenses are reduced by tax-free benefits received and by expenses used to claim the AOC and LLC; total interest received is excludable only if combined principal and interest received do not exceed the expenses.

Constructive distributions:

Some transactions may be regarded as constructive distributions; can be considered dividends or nondividend distributions, and may be taxable to the shareholder. Examples: -payment of personal expenses: corp pays personal expenses on behalf of employee, they are distribution rather than expenses -unreasonable compensation: if salary is unreasonable for services performed, excess salary can be distribution -unreasonable rents: if corp rents property from shareholder and the rent is unreasonably high, excess is distribution -cancellation of debt: may be treated as distributions -property transfers for less than FMV: excess may be treated as distribution -below market or interest-free loans: uncharged interest may be treated as distribution