Tax implications of dividends from Regulated Investment Companies (RICs)
Understanding the tax implications of dividends from Regulated Investment Companies (RICs), such as Real Estate Investment Trusts (REITs) and Business Development Companies (BDCs), is crucial for investors, particularly because these dividends are typically classified as non-qualified. Unlike qualified dividends, which benefit from lower long-term capital gains tax rates, non-qualified dividends are taxed as ordinary income, potentially leading to higher tax liabilities depending on the investor’s tax bracket.
Since RICs are required to distribute at least 90% of their taxable income to shareholders, the majority of these dividends do not qualify for the reduced tax rates and are taxed at the investor’s ordinary income rate, which can be as high as 37% (if you are lucky enough to be in that high tax rate). This can reduce the after-tax return on these investments, making it important for investors to consider the tax implications when incorporating RICs into their portfolios. Fly High Investing advises careful consideration of these tax factors to maximize after-tax returns, especially for income-focused investors.
To that effect, investors can mitigate the tax impact by holding RIC investments in tax-advantaged accounts such as 401(k)s, Roth IRAs, or traditional IRAs. In these accounts, dividends can grow either tax-free (in the case of Roth IRAs) or tax-deferred (in traditional IRAs and 401(k)s), allowing investors to avoid immediate taxation on the income. This can significantly enhance the overall return on these investments by eliminating or deferring the tax drag associated with non-qualified dividends.