Are Your Prepared for Income Taxes?

Don’t be surprised by income taxes on your dividend income.

I certainly don’t know everything there is to know about each investment and the potential tax implications of those investments. Yesterday one of my readers, Greg, asked me a question about dividends and ETFs.

“I have a question that maybe you can shed some thoughts on. I have several long-term ETF’s in a taxable account. I thought since holding these for at least 61 days, although in my case – several years, that the dividends distributed would be ‘qualified.’ Instead they show as ordinary in my YTD tax activity on Fidelity.” He goes on to say, “When I look at the prospectus, every ETF I own, and others that I have in the IRA (which doesn’t apply), and those I want to own have the following statement: Dividends and capital gains distributions received from the fund will generally be taxable as ordinary income or capital gains.”

His question, in light of his findings was, “Do you know of any ETF’s that distribute qualified dividends?” That was something I thought I could easily determine. I was wrong.

Duck Duck Go Searches

I started trying to find ETFs that fit the requirements and quickly realized that there were no easy fixes. That is a bit frustrating. I could not find a screener that fits the bill.

Exploring the 1099-DIV Statements

I had never really looked at this before, probably because most of my dividends are paid from our ROTH and IRA accounts. However, I looked at the 2023 1099-DIV statement for my oldest granddaughter’s UTMA account to see what it said. Most of the dividends were qualified, including the following ETFs: VYM, DGRO, FTEC, and FHLC.

I also looked at the sectors in ETF SCHD, and I don’t see any Real Estate. If a mutual fund or an ETF holds real estate investments, then those dividends are non-qualified. This can result in a higher income tax bill.

Fidelity’s Tax Forms and Information Screens

If you want to see what your own taxable account looks like for 2024 YTD, Fidelity offers a view that may help you. Start with Accounts & Trade, select Tax Forms & Information, Select the Time Period, and then Select the 1099 for a taxable account. You can also look at previous years. The following two images are from our 2023 1099-DIV statements.

You can also View Your YTD Tax Activity and Select the Account.

IRS Section 199A Dividends

As a general rule, if you have a lot of income, you don’t want to have REITs in your taxable accounts. This includes your own accounts and perhaps the UTMA accounts for your children or grandchildren. What we often neglect to see, however, is that an ETF can have REIT investments. Certainly a REIT-focused ETF would be a poor choice for a taxable account.

“Investors will generally find Section 199A dividends within mutual funds or ETFs holding REIT stocks. Individual REIT stocks also may pay Section 199A dividends. The presence of this potential deduction can be a significant factor to consider when selecting REIT investments.” SOURCE: SmartAsset

Some Insights from The Money Maniac

What are Section 199a Dividends?

“Section 199a dividends are cash distributions paid by certain REITs (Real Estate Investment Trusts). These dividends get their name from Section 199a of the tax code, which was established as part of the 2017 Tax Cuts and Jobs Act. This act was a comprehensive tax reform effort aimed at stimulating economic growth and providing tax relief for individuals and businesses. The main benefit of Section 199a dividends is that they qualify for a special 20% tax deduction. However, the window of opportunity to take advantage of this deduction is closing. The law will expire on December 31, 2025, unless Congress acts to extend it before then.” SOURCE: Money Maniac

Fidelity Learning Center – Tax Efficiency

Conclusion

One way to reduce the impact of income taxes due to “ordinary dividends” is to look at Seeking Alpha’s Holdings Breakdown. If I enter the ticker symbol SCHD, I can see the allocations of this ETF to each sector. REITs do not appear in the list.

I will be more mindful of this going forward. For example, I noticed that VYM does have a very small exposure to REITS: 0.02%. That isn’t enough to concern me, and we don’t hold VYM in any of our brokerage accounts. However, it is in the grandchildren’s UTMA accounts.