The first year I created a portfolio, I also made a very silly - yet common - investment mistake. This is what I did that year: I bought, I sold. I bought, and I sold. Then, I bought and sold some more. Then - I filed my taxes. I think that was the thickest packet of information I ever sent to anyone, let alone the IRS. I felt horrible, because I'm positive that envelope represented one small, formerly healthy tree.

I felt even worse when that bottom line on the 1040 revealed a much worse scenario than I imagined. I just didn't understand the dour circumstances that could be wrought by a combination of dividends, capital gains, and the IRS. While tax laws were a little different in 1999, and my attitude about long-term relationships has improved somewhat, a few dividends continue to act like a whiney significant other when I screw up:

Dividend: But I'm qualified, dear. How could you mess this up?
Me: Ok, ok. So I didn't hold onto you long enough.
Dividend: (sniff) I told you so, didn't I? Just one more day, and you could have had it all?
Me: C'mon - you never, ever told me you were qualified. I never knew!
Dividend: Well, it's your loss. A permanent loss, I might add (wailing).
Me: (shrugging). Oh. Darn. Well, so long?

This dividend was qualified, no doubt. It was right there in black and white on box 1b of form 1099-DIV. And, I did mess up, because qualified dividends are - supposedly - better than ordinary dividends for the taxpayer. Ordinary dividends are the most common type of distribution paid by corporations to their shareholders, and these payments count as ordinary income (like wages, salearies, tips, etc.). Qualified dividends, on the other hand, are taxed at a much lower rate than ordinary dividends, but they're a pain. I'll tell you why?

1. Dividends: This word describes cash, stocks, or other property that a company, trust, estate, partnership, or a corporation pays us for owning stock or any other investment in their business. Dividends are usually paid in cash and for dividends worth more than $10, the payor should send us a Form 1099-DIV (Dividends and Distributions, link provided in previous paragraph) to file with our taxes. Trusts, estates, partnerships and an association that is taxed as a corporation will send a Schedule K-1, a form that indicates the amount of dividends taxable to us. However, even if these forms don't arrive in time to file with our taxes, we're still held responsible for admitting this income.
   
   
2. Ordinary (taxable) dividends: Outside of my explanation above, we can most often assume that any dividend that we receive on a common or preferred stock is an ordinary dividend unless the payor specifies otherwise on the 1099-DIV. Once this form arrives, look carefully to make sure that the "ordinary dividend" amount is added with any other 1099-DIV that might arrive, and then drop-kick that total into line 9A on the good ol'1040. However, if that total is over $1,500, we also need to fill out and attach a Schedule B. (on the IRS site this form is attached to Schedule A), or fill out Schedule 1 and attach it to that 1040A. The taxes we pay will be 5% when dividends fall in the lowest tax brackets and 15% otherwise, just like long-term capital gains. Not shabby.
   
   
3. Qualified dividends: When that "1b" box on the 1099-DIV form is checked as a qualified dividend, we have a gem on our hands. However, this statement is true only if we mind our p's & q's. For instance, some dividends might state that they are qualified, but they may not be if certain stipulations are ignored.

If you already have your 1040 tax booklet, turn to page 20, and you'll learn why the 1099-DIV is a document that can't be taken at face value. If you don't have a tax booklet, you can find basically the same information at the IRS explanation about dividends. Then, go to a search engine and type "qualified dividends new tax law" and read a few commentaries about this topic that were written about this same time last year. Is this fun? Frankly, I'd rather do laundry.

Unless we purchase shares in a fund that states we will own equities that pay qualified dividends (and?how far can we throw that piano?), then the possibility exists that, although we might search for stocks that pay qualified dividends, we might not know that those dividends are qualified until that 1099-DIV arrives. Additionally, if we know that a corporation pays a qualified dividend, we have to set our alarm clocks to purchase this stock at a specific time and hold it for a stipulated amount of time. In other words, if we seek a relationship with a qualified dividend, we may have to compromise far more than if we simply purchased a stock based on sound financials.

But, I'll give you a few hints as to what "qualifies" a qualified dividend: The dividend must be paid by a U.S. corporation or a corporation incorporated in U.S. possession, or by a foreign corporation located in a country that is eligible for benefits under a U.S. tax treaty that meets certain criteria, or on a foreign corporation's stock readily tradable on an established U.S. market (e.g., an American Depositary Receipt or ADR).

Unfortunately, I haven't found a site that lists corporations that sell qualified dividends. Until that magic day arrives, we all can avoid these headaches (and whiney Dividends) if we simply hold stocks that pay dividends - or stocks that don't pay dividends - for more than a year. It's that simple. See Schedule D for your options.

Good Luck!
Linda Goin