Dividend Tax Changes Cause Headaches for Some Taxpayers
By Jim Balow, The Charleston Gazette, W.Va.
Knight Ridder/Tribune Business News
Mar. 26 - If you're fortunate enough to have earned dividends from stocks or mutual funds last year, income tax season may be causing a few more headaches than usual this year.If you haven't already filed your tax returns, you may want to wait until the last minute. Here's why.
Congress did many taxpayers a favor last year when they passed the optimistically titled Jobs and Growth Tax Relief Reconciliation Act of 2003. The law, which President Bush signed in May, lowered the tax rates on dividends and capital gains.
But as a possibly unforeseen ripple effect, mutual fund companies and brokerage houses like Charles Schwab had to set up new systems to track and report the dividends paid to investors. Some dividends qualify for the new rates; some don't.
Investment companies by law must report the amount of dividends paid to clients for the previous year by the end of January on what's called Form 1099-DIV. In a typical year, usually because mutual funds recalculate their dividends and capital gains, brokers have to send out corrected forms to between 5 percent and 8 percent of their customers, said Patti McClanahan, director for tax policy at the Securities Industry Association in Washington.
This year though, the correction rate could go up three times or even five times, depending on who you talk to, thanks to the confusion in calculating the new tax rates.
"It may be the cloud in the silver lining of the tax law changes," said Morrison Shafroth, a spokesman for Charles Schwab in San Francisco.
"The issue is holding period requirements," he said. "In order to be a qualified dividend [a dividend that qualifies for the new lower rates], a security has to be held at least 60 days."
Keeping track of individual stocks is not too complicated. Mutual funds, however, which buy and sell dozens of stocks throughout the year, faced a greater challenge, Shafroth said. "Before, it wasn't an issue. This required pretty significant system changes."
McClanahan said her trade group asked the Internal Revenue Service to give investment companies more time to report dividends.
"This is the most historic change they've had in equities for years. We asked the IRS long ago: 'If you go to Feb. 15 [deadline for issuing 1099-DIV forms], it would give us enough time. It would just save us a lot of headaches.'
"Historically the IRS has been reluctant to do it. With the change, we thought why would be willing to do it, be they didn't."
For some taxpayers, the tax law changes created a different sort of confusion, said Rick Slater, a partner at the Charleston accounting firm Simpson & Osborne.
"Some people have read the language loosely and figured every dividend qualifies" for the lower rates. Not so, he said.
Despite what they're called, dividends paid on money market accounts do not qualify, nor do those paid by real estate investment trusts (REITs). "In this state, a lot of people have insurance policy dividends," he said. "They do not qualify."
Slater said he's aware of the problem of corrected 1099-DIV forms. "This year the volume is definitely up. For people who filed early, it's definitely a pain. They have to file an amended return."
If you use an accountant to figure your taxes, you could feel the pain in your wallet.
"There could be a cost associated with an amended return," he said. "We, as a firm, it's not our fault. We'd have to go back and process all the forms. In most cases the cost is minimal -- 5 to 10 percent of what they would normally pay. I'm sure they're not too happy about that.
"The lesson: I always advise folks if they have complicated returns to hold off in case the IRS puts out pronouncements or guidance in case of errors, or they get corrected 1099s.
"The only issue is if people are expecting a bunch of money back. They want their money right away.
"We look at typical data. If John typically gets $2,000 back, we'll file right away. If he gets a little back or has to pay, we'll hold off 'til April 15 or, in some cases, file for an extension."
McClanahan said there is no deadline for sending out corrected 1099 forms. The pace has slowed but they're still going out.
Her advice echoed that of Slater: "It might be a good idea to hold off."
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