One of the current benefits dividend investors can receive right now is the ability to receive favorable tax treatment on qualified dividends. Until the end of 2012 (unless Congress makes changes), it is possible to have certain dividends taxed at the long-term capital gains rate.

The current long term capital gains rate (again, extended through 2012) caps at 15%. For those in the lowest tax brackets, there is no tax at all on long term capital gains. Short term capital gains, though, are taxed at your regular income rate. Non-qualified dividends are also taxed at this rate. This means that, if you are in the 28% tax bracket, your non-qualified dividends will be taxed as ordinary income. With the proper planning, though, you can ensure that most of your dividends are qualified – paying no more than 15% on your dividend income, no matter your income bracket.

Making Sure Your Purchases are Qualified

If you want to be able to claim your dividends as qualified, you need to own the stock or mutual fund in question for more than 60 days in the 121 days preceding the 60 days before the ex-dividend date. This means that you need to think carefully about when you buy shares if you want the tax favored status that comes with qualified dividends.

Before you purchase a share of a company or a mutual fund, find out when the dividend will be paid out. With a company, you can use the ex-dividend date as your guide, or you can simply make your purchase after the dividend has been distributed.

The same is true of buying mutual fund shares. Look at the fund’s distribution schedule and find out when dividends and capitals gains are normally distributed. Make your purchase just after a distribution takes place. This way, you will be able to ensure that you meet the definition of “qualified,” and receive the long term capital gains rate as you pay taxes on your income.

Paying Taxes on Reinvested Dividends

It’s important to realize, too, that you will pay taxes on reinvested dividends. Even though you don’t receive the cash in hand, it is still considered income by the IRS. So take this into account when purchasing shares in a new company or mutual fund. Just because you plan to have the dividends automatically reinvested doesn’t mean you are protected from paying taxes. The only way to avoid it right now is if your dividend investments are held in a tax advantaged retirement account.

One of the ways that you can prepare for the future, and build your wealth, is to invest in dividend stocks. Not only do dividend stocks provide you with the chance to enjoy capital appreciation, but you can also receive regular dividend income.

Dividend growth stocks can add even more to your portfolio. These are stocks that have the ability to grow in the future, and continue to grow their dividends. You can start with some of the dividend aristocrats, and see which are likely to continue to provide growth in dividends and in value.  Dividend growth stocks can offer you the chance to build wealth and income.

How to Pick Dividend Growth Stocks

 
As you decide which stocks to include in your portfolio, you should look at your options, as well as your goals. While you want your dividend stocks to reflect your future needs and desires, you also want to make sure that you are getting a good deal.

One thing you can do to calculate stock valuation is to use the dividend growth model. Before investing in a stock, it can help to have an idea of whether it is a good deal. Is it inexpensive for its expectations? Is it likely to grow enough in the future to justify its current valuation? Looking for an undervalued dividend stock can be a good move.

You can also look at some of the fundamentals of the company. Is the business model stable? Does the company manage the company in way that is likely to ensure that growth can be sustainable? Some of the best choices for a dividend growth portfolio are a bit boring: Mature companies with a history of paying dividends – and raising them. Sound balance sheets can also be good indicators that a dividend stock is a good choice.

Selling Your Dividend Growth Stock

 
When you buy a dividend growth stock, remember that you do so in an effort to hold on to something that will provide you with value now and in the future. That means that dumping it at the first sign of market trouble isn’t the best choice. The decision to sell a stock should not be taken lightly.

Before selling, consider your goals. Long-term, is the stock still likely to do well? If so, it might be worth it to hold on to the stock for a little bit longer, wait for it to recover. Plenty of great companies see their stock prices fall during a crash; that just means it’s a good time to get good deals. Instead of selling as a knee-jerk reaction to the markets, consider selling only if something changes fundamentally about the stock.

For the last few years, there have been tax breaks for investors with long-term capital gains, as well as for qualified dividend investors. As part of a tax deal at the end of 2010, favorable tax rates on qualified dividends were extended through 2012, so the same tax rates apply to qualified dividend income as apply to long-term capital gains. Right now, that means that those in the 10% and 15% brackets pay no taxes on such income, and those in higher brackets pay 15%.  (Everything could change starting in 2013, depending on what Congress decides to do.)

This situation means that many people have been enjoying tax-free dividend income – as long as it’s qualified. You need to have an understanding of qualified dividends vs. unqualified dividends if you expect to fully take advantage of your tax status:

Qualified Dividends

Information on dividends, and how they are taxed, can be found in IRS Publication 550. “Qualified” status is awarded to dividends that are paid by a U.S. corporation, or a properly qualified foreign corporation. In most cases, the dividends you earn as a result of stock held in most U.S. C corporations are considered qualified dividends. Additionally, you must meet a specific holding period.

In order to be “qualified,” the IRS says that you must own the stock for more 60 days during the 121-day period beginning 60 days prior to the ex-dividend date. As long as you keep things relatively simple, this is fairly easy to figure out. Things start to get a little more difficult when you use option strategies. You might need a tax professional to help you sort things out in more complicated scenarios.

Non-Qualified Dividends

Even if your stock holdings meet the requirements above, there are some dividends that are never treated as “qualified.” You should be aware of these dividends, so that you don’t make the mistake of paying less in taxes than you owe. Here are the items that the IRS says will never be treated the same as “qualified” dividends:

• Capital gains distributions.
• Dividends paid from tax-exempt corporations or famer’s cooperatives.
• Dividends received from deposits with credit unions, building and loan associations and financial institutions that are structured similarly.
• Payments received in lieu of dividends, if you have reason to know that they are not “qualified” dividends.
• Dividends paid on ESOPs maintained by corporations for their employees.
• Dividends from stock shares that require you to make related payments for positions that are in substantially similar or related properties (such as in the case of a short sale).
• Shown dividend payments in box 1b of Form 1099-DIV from a non-qualified foreign corporation.

If you have questions about the status of your dividend payments, it’s a good idea to double check with a tax professional or investment professional. Non-qualified dividends are taxed at your normal tax rate, so if you are in a marginal tax bracket above the 15% level, you will have to pay that tax rate.

When it comes to dividend stocks, the general rule is buy and hold. So, a number of people believe that they need to stick with a dividend stock, even after a dividend cut. And, while abandoning a stock at the first sign of a small dividend cut may not be quite your style, any cut should provide you with food for thought.

Reasons a Dividend Cut Matters

When a company cuts its dividend, it matters. It’s true that a dividend aristocrat that stops raising its dividend each year, and falls off the Dividend Aristocrats list, can be a concern. But a company that cuts its dividend – or eliminates it altogether – is something different. This can be an indication that things are going to change, and maybe not for the better. Here are some things a dividend cut can presage:

1. Losing market share: In some cases, a company that has to cut its dividend does so in response to the way its market share is shrinking. When that happens, that might mean that the company is losing ground – and may not be able to provide the kind of growth that will result in sustainable dividends in the future.
2. Cash problems: A company that cuts its dividend often doesn’t have the cash to continue to give some of its profits to shareholders. This can mean that revenues have fallen (due to market conditions or to some other problem), or that expenses have risen. It can also be a sign of mismanagement. In any case, cash problems can be an indication that problems are on the way. A dividend cut can be indicative of problems.

Before you get too hung up on dividend cuts, though, consider the situation. Following the global financial crisis, almost all financial institutions cut their dividends. They were all on shaky ground, and cash was a real problem. However, now many banks are starting to raise dividends again – although it might be years before dividends recover. In some cases, a dividend cut is only temporary, and dividends are likely to be raised again. However, if you are relying on dividends for stable income, a stock that regular cycles through cutting and raising dividends is usually not your most reliable choice.

On the other hand, though, it is important to consider that there are companies out there that are managed so well, and have enough market share, revenue, and profitability that they can keep raising dividends, even during times of economic upheaval when other dividend stocks are faltering. (This quality is what makes the dividend aristocrats so attractive to many.)

Getting rid of a dividend stock is a serious decision. A dividend cut might be a sign that the company is in trouble, and it might be time to unload. However, before you decide to sell, it’s a good idea to consider your options, and make sure that you can replace the stock with another dividend stock. One that might provide you with better performance and more reliable dividends.

Value investing is back.  Investors are flocking to anything with perceived value to avoid the market swings we are seeing every day.  There are many different methods and formulas you can use to identify undervalued dividend stocks.  The dividend growth model is one that we have mentioned before.  Discounted cash flow and comparing current dividend yield to average yields are also often used.

We didn’t use any of those models to identify these three stocks.  Instead we first found stocks trading at a price to book value ratio of less than 1.  We further filtered that list down by removing any stock with a P/E and PEG ratio above their specific industry average.  It’s important to compare P/E ratios to industry averages instead of index averages because not all industry trading at the same level.

After drilling down into value we then sorted stocks by dividend yield to only include those with a yield of 3% or more.  We ended up with over 20 stocks many of which are REITs.  Each of these stocks has a story and it’s important to do your homework to determine if these fundamentals are predicting a big upside or a possible problem at the company.

A good example would be two stocks you’ve probably heard of before – Whirlpool and Computer Science Corp.  Both had disappointing earnings results recently and have analysts concerned about future growth.  Other stocks such as Transocean have solid fundamentals, a high yield and the backing of many analysts making it one of the best dividend stocks on the list.