Answers to your tax questions. . .On dividends and interest

February 8, 2002

M.E. 02TAXQ3


Answers to your tax questions. . .On dividends and interest

By Lawrence Farber
Contributing Writer

A company I own shares in sent me stock of a subsidiary and advised me to report the distribution as income. Aren't stock dividends tax-free?

Generally, yes, but not when the stock isn't in the same company. In this case, you owe tax on the market value the shares had on the date of distribution. That value is also your basis for figuring gain or loss if you later sell them.

I bought shares in a mutual fund last August and received a dividend in December. The Form 1099 the fund sent me shows the dividend as a long-term capital gain. Do I pay only 20 percent tax on it, even though I've owned the shares less than a year?

Yes. List it on Schedule D with any other long-term gains or losses you had in 2001. If you had no others, you don't need to file Schedule D. Instead, show the dividend on line 13 of Form 1040, and use the capital gain tax worksheet on page 34 of the 1040 instructions to figure your total tax.

To get me to open an account last year, a local savings bank gave me a radio that retails for about $100. Do I have to report this as income?

Yes. The value of a gift worth more than $10 ($20 if you deposited more than $5,000) counts as interest income. The bank should have included its cost, not the retail price, in the interest total on the Form 1099 it sent you.

To take advantage of Last year, I sold my brother an acre of land for $200,000, payable in 10 annual installments, with interest at 6 percent. That's less than the minimum rate set by the Treasury for long-term contracts at the time of the sale. Does that mean I have to pay tax on more interest than I'm collecting?

No. Ordinarily, a seller is taxed on the forgone interest if he charges less than the "applicable federal rate." But the tax law specifies a 6 percent minimum rate when land is sold to family members for $500,000 or less in a given year. Since that's what your contract calls for, you won't be penalized.

To take advantage of a high-rate certificate of deposit offered by my bank last year, I had to borrow $5,000 from the bank to make up the minimum $50,000 investment required. Do I report my net interest income from the CD after subtracting what I paid on the loan?

That would be logical, but the answer is No. Even though both transactions are with the same financial institution, you must report all the interest you earn from the certificate on Schedule B. You can take an investment-interest deduction for your loan payments on Schedule A, provided the total of such interest doesn't exceed your net investment income from all sources.

I cashed in some US Savings Bonds last year and received a Form 1099 showing taxable interest equal to the difference between the purchase price and the redemption value. But I reported the interest annually and paid tax on it while I owned the bonds. How do I straighten this out?

On your 2001 return, list the entire amount along with other items of interest income, and show a subtotal on line 1 of Schedule B. Below that, list the amount you paid tax on in earlier years and label it "US Savings Bond interest previously reported." Subtract this figure from the subtotal above, and show the difference on line 2.

Instead of taking a cash dividend from a company, I bought additional stock in it at a discount through its dividend reinvestment plan. How do I handle this transaction on my tax return?

List dividend income equal to the market value of the new shares as of the dividend payment date, plus any service charge that was subtracted from your cash dividend. You can claim an offsetting deduction for the charge by lumping it with your miscellaneous itemized expenses, if they total more than 2 percent of your adjusted gross income.

A small mortgage loan I made to my brother-in-law came due last year, but he couldn't repay it. I accepted a new note covering the loan principal and $1,500 in unpaid interest. Do I owe tax on the interest for 2001?

No. You report the interest income on your return for the year you actually receive the cash. By the same token, the new note doesn't give your brother-in-law the right to deduct the unpaid interest on his return for 2001, since no money changed hands.

A stock in my son's custodial account declared a cash dividend last December but didn't pay it until January. The boy will be 14 this year. Will the dividend be subject to the kiddie tax?

No. Your son's income in 2002 and thereafter will be taxed at his rate, not yours. Dividends generally count as income for the year paid, but mutual fund dividends are an exception: They're considered income for the year they were declared, provided they're distributed no later than the following January.

Thanks to the Federal Reserve's rate cuts, I sold some bonds in October for $1,500 more than they cost me. Since I didn't collect the semiannual $600 interest due three months later, does that reduce my taxable gain?

Yes, but the price the purchaser paid you included three months' interest—about $300—that had accumulated while you owned the bonds. You should subtract the $300 from your capital gain, but you must report it as interest taxable at your regular rate, even though it isn't reflected in the Form 1099 the bond issuer sent you.

Last year, I bought some municipal bonds that were selling at a discount from face value because they were paying less than the current market interest rate. Will I owe any tax if I later sell the bonds?

Yes. Although the bond interest is tax-exempt, the profit due to the discount is taxable. What's more, it's treated as interest income, not capital gain. However, you might consider reporting a proportionate amount of the discount annually, starting with your 2001 return, rather than waiting until you sell the bond. You'd pay tax on it as interest income each year, but your profit from any discount remaining when you sell would be taxed at the capital gain rate.

A real estate investment trust (REIT) I own shares in designated a portion of my 2001 dividend as a "return of capital." Do I report this with other dividends on my return for 2001?

No. Subtract it from the cost basis of your REIT shares. But you don't need to report the distribution unless it reduces your cost below zero. Say the distribution was $30 a share and your original cost per share was $20. You'd then show the $10 difference as a capital gain on Schedule D. That may happen in the future if such distributions accumulate over the years, so be sure to keep track of them.


In our next issue:
Answers to your tax questions on capital gains and losses.


Lawrence Farber. Answers to your tax questions. . .On dividends and interest. Medical Economics 2002;3:78.