Tax Savings Guide

Generally, dividend income is “ordinary” income. This means that dividend income is taxed at the usual income tax rates. Your “usual rates” depend on which “ordinary” tax brackets your income falls into. The new tax law changes this general rule for dividend income.

Dividend income is now taxed at no more than 15%. This has the effect of giving dividend income favorable tax treatment, somewhat similar to the favorable tax treatment that exists for capital gains. For lower income taxpayers in the 10% and 15% tax brackets, this maximum rate will be 5%, not 15%. This favorable tax treatment is scheduled to end on December 31, 2008.

Planning Opportunity: You may want to take advantage of the following planning opportunity.

• Invest in Stocks and Mutual Funds: This tax law change gives you an incentive to invest in the stock market instead of bonds, certificates of deposit, and other investments that pay interest.

Example. Suppose you have a choice between investing $10,000 in a stock that pays a 3% annual dividend or a certificate of deposit that pays 3% annual interest. The stock will pay $300 of taxable dividend income, while the certificate of deposit will pay $300 as taxable interest income. Further, suppose you are married and you and your spouse have a combined annual income of $100,000, with your top bracket of income at 25%. The income taxes on the interest income will be $75, and the taxes on the dividend income will be $45. Okay, it’s not huge, but it helps a little.