About Taxation of Preferred Stock

Investors like preferred stocks before they pay out in large dividends. Taxes do reduce the total returns for the preferred shares, so it is important to identify the tax provisions applicable to your preferred shares. You'll want to know before purchasing your preferred stocks what the taxation laws and rules are.

Identification

The Internal Revenue Service (IRS) will realize that capital gains and investment are earned as you sell profits. The IRS classifies preferred dividends as either ordinary dividends or qualified dividends. Ordinary dividends are taxed at maximum rates of 35 percent, while qualified dividends are capped at 15 percent. For preferred shares to qualify for this rate, the shares must be held for at least 61 of 120-days of the holding period.

Considerations

The IRS extends lower capital gains tax rates to shareholders who hold stock for longer than a year. Maximum long-term capital gains tax rates are held at 15 percent, while short-term capital gains are held at 35 percent. Tax law is not permanent and it varies with how the economy and political system is doing. It is important to make financial decision based on your income, the economy and using the tax code. Holding onto poorly performing preferred shares just to get dividends, may actually result in losing money rather than gaining it.

Investments

Before choosing whether to hold onto preferred stocks, you should consult a financial expert. The chance of losing money may not be worth the payoff of the dividend. Also confer with the financial expert if you have an ordinary or qualified dividend, and how the interest rate has been calculated.