by George G. Jones and Mark A. Luscombe

In our column for the issue of Feb. 23-March 14, 2004, we pointed out several problems with determining what constitutes qualified dividends for purposes of filing 2003 tax returns.

We pointed out that a technical corrections bill was before Congress that would clarify a number of issues, but that the bill had not yet passed Congress, and the Internal Revenue Service had not clarified whether it would follow the corrections for purposes of reviewing 2003 tax returns.

Now, although Congress has still not passed the technical corrections bill, the IRS has stated that it will follow the qualified dividend provisions of the technical correction legislation for purposes of 2003 returns.

Although this clarification of the IRS position comes too late for many Form 1099s and the IRS forms and instructions, the IRS has promised to amend its online instructions and publications, and Form 1099 issuers will be in a position to issue revised 1099s. The clarification does come in time for partnerships to issue K-1s to their partners that reflect the revised IRS position.

The corrections bill
Section 2 of the Tax Technical Corrections Bill of 2003 (HR 3654) provides amendments to the Jobs and Growth Tax Relief Reconciliation Act of 2003, which lowered the tax rate applicable to qualified dividends.

The first technical correction in Section 2 of the bill clarifies the calculation of gain subject to tax at the 25 percent rate by limiting that gain to the net capital gain determined without regard to qualified dividend income.

The second technical correction in Section 2 of the bill changes the cross-reference to Code Sec. 246(c) for purposes of determining the qualified dividend holding period. This amendment has the effect of changing the holding period requirement for qualified dividends on preferred stock attributable to a period aggregating in excess of 366 days to 91 days from 61 days.

The third technical correction in Section 2 of the bill seeks to change the period surrounding the ex-dividend date, within which the 61-day holding period for qualified dividends on common stock must be met, from 120 days to 121 days. It makes a similar change for the period within which the 91-day holding period for qualified dividends on preferred stock must be met — from 180 days to 181 days.

This technical correction is designed to solve the problem of a taxpayer purchasing the stock on the day before the ex-dividend date and not being able to establish the required holding period before the 120-day or 180-day time period expires. To fully achieve this change, however, an additional technical correction was required to the Taxpayer Relief Act of 1997 to amend Code Section 246. This change is included in Section 7(d) of the corrections bill, which will become significant when we review what the IRS said that it will accept as already passed.

The next technical correction in Section 2 of the bill clarifies that the long-term capital loss treatment associated with qualified extraordinary dividends applies not just to individuals, but to any taxpayer to which the provision may apply, which also picks up trusts and estates.

The final set of technical corrections in Section 2 of the bill addresses the treatment of qualified dividends in the pass-through entity context. The provisions of the JGTRRA with respect to dividends from a regulated investment company or real estate investment trust are revised to set forth the rules directly rather than by reference to the dividends received by corporate shareholders. (For more, see Rywick, page 16.)

The technical corrections also clarify that distributions by a RIC or REIT with respect to earnings and profits from a period prior to becoming an RIC or REIT may be qualified dividends. RIC and REITS are further given until the due date for the 2003 1099-DIV forms to notify shareholders of the amount of qualified dividends with respect to tax years ending on or before Nov. 30, 2003.

Finally, pass-through entities, including partnerships, S corporations, common trusts funds, trusts and estates are given the same treatment as RICs and REITs in their ability to pass on qualified dividends to their owners with respect to non-calendar tax years beginning in 2002 and ending after Dec. 31, 2002, provided that the dividends were received by the entity on or after Jan. 1, 2003.

Information Release 2004-22
On Feb. 19, 2004, the IRS promulgated News Release IR-2004-22. In the release, the service stated that, since the leadership of the House and Senate tax writing committees have made representations that Congress intends to enact technical corrections with regard to what constitutes a qualified dividend effective as of Jan. 1, 2003, the Treasury Department and the IRS, in order to reduce the burden of requiring amended dividends statements to investors and amended returns by those investors, will apply the technical corrections in Section 2 of the technical corrections bill as if the legislation were already enacted.

The IRS also stated that it plans to revise various publications and form instructions to effect these changes. These are Publications 17, 553 and 564, and the instructions to Forms 1040, 1040A, 1040NR, 1041, 1065, 1065-B, 1099-DIV, 1120S and 8865.

Although the IRS failed to mention Section 7(d) of the technical corrections bill as part of the bill that it is treating as already effective, the information release does specifically discuss the revised 121-day and 181-day holding periods as part of what they are trying to address. Tax practitioners should probably assume, therefore, that Section 7(d) of the technical corrections bill is treated as currently effective as well, along with Section 2 — at least so far as the determination of what is a qualified dividend is concerned.

Responding to pressure from Congress, 1099 issuers and the tax practitioner community, the IRS has promulgated guidance permitting taxpayers to treat as currently effective the qualified dividend provisions of the tax technical corrections legislation currently before Congress. Although some 1099 issuers may have held up issuance until these issues were resolved, for many more the Form 1099-DIVs had already been issued before this clarification was made, since the IRS specifically denied permission to 1099 issuers to delay their issuance.

For those tax practitioners who have already filed returns that do not reflect the technical corrections, amended returns should now be filed, although for some taxpayers the cost of the amended returns may more than offset the tax benefit of claiming additional qualified dividends. For 1099 issuers that have already issued 1099s that do not reflect the technical corrections, revised 1099s should now be issued.

In addition, taxpayers and tax practitioners using software packages to file their returns will want to make sure that they have downloaded the latest updates to insure that their software takes into account the changes made by the technical corrections legislation.

George G. Jones, J.D., LL.M., is the managing editor of Federal and State Tax, and Mark A. Luscombe, J.D., LL.M., CPA, is the principal analyst of Federal and State Tax, at CCH Inc., in Riverwoods, Ill.

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