Taxpayers currently enjoy a maximum 15% tax rate on most dividends they receive from U.S. corporations and many dividends they receive from non-U.S. corporations (i.e., “qualified dividends”) as well as longterm capital gains (i.e., gains on capital assets held for longer than one year). However, barring Congressional or Presidential action, these maximum rates will expire under the sunset provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 and maximum rates of 39.6% for qualified dividends and 20% on long-term capital gains will go into effect starting January 1, 2011.
Taxpayers may wish to consider pulling out cash that may be idle in corporations before the end of 2010 to avoid the higher rates that may be in effect beginning in 2011. This may be accomplished by either triggering a dividend distribution or a stock redemption, which will produce either capital gains treatment or deemed dividend treatment. While the rules under which a redemption—a situation in which a corporation buys stock from a shareholder—will produce a capital gain rather than a deemed dividend can be complex, there is an extra benefit in getting capital gain treatment in that the shareholder’s basis in the stock redeemed will reduce the amount subject to tax, which is not the case if the redemption is treated as a deemed dividend. However, the treatment of a redemption occurring in 2010 is less important because the maximum tax rate is 15%.