Dividends and Capital Gains

Some of the toughest wrangling over the 2003 Act’s provisions involved cutting taxes on corporate dividends paid to individuals. When all was said and done, however, the new law contained a lot of good news for investors.

Background

For years, many experts have discussed the unfairness of taxing corporate dividends twice — once when profits were earned by the corporation and reported on its tax return and, again, when those profits (or a portion of them) were paid out to shareholders as dividends. More unfair, said the critics, was the fact that these dividends were taxed as ordinary income, at up to the highest marginal rate in effect for the year (38.6% in 2003, prior to the new law’s rate changes).

Capital gains taxes have also been a source of controversy over the years. When a taxpayer sells or otherwise disposes of an appreciated capital asset — an investment, for example — the difference between the sale price and what the taxpayer paid for the asset is generally considered capital gain.

Under pre-2003 Act law, net capital gain was taxable at a maximum rate of 20% (10% for gain that would otherwise be taxed in the 15% or 10% tax bracket if it were ordinary income). For gain to qualify for the 20%/10% rates, the asset must have been held for more than one year. Assets held for more than five years could qualify for even lower rates — 18% (with a holding period starting after 2000) and 8%, respectively. Capital losses are deductible in full against capital gains, and any net capital loss is deductible against ordinary income of up to $3,000 a year. Several exceptions and restrictions apply to these general rules.

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