Some investors rely on dividends to generate much of their portfolio income. If you own stocks through a broker, your twelvemonth-end tax forms mightiness show much of the money you received during the year as a payment in lieu of dividends, listing it on an individual basi from your regular dividends. This can create a tax hassle that actually could cost you more than at tax time. Below, you'll learn more about substitute payments in lieu of dividends and what you can do to avoid them.

How payments in lieu work
Substitute payments in lieu of dividends result from your broker lending come out of the closet the stock you own to short-sellers. Those short-sellers take up your shares and then sell them on the visible market, dissipated that they'll go down in rate before they have to repurchase them and return the shares to you.

If the stock pays a dividend during the period that they've borrowed shares, then the squab-sellers have to reimburse you for the lost dividend income. This reimbursement is the substitute defrayal ready-made in lieu of the dividends you would other have received straightaway from the company issuing the parentage.

The downside of payments in place
The whole point of payments in place of dividends is to work the original shareowner whole. However, there's a huge downside to payments in lieu: they don't qualify for favorable tax rates on qualified dividends. Presently, qualified dividends have uttermost rates of 0% to 20% contingent on your regular revenue enhancement bracket, but they always save you at to the lowest degree 10 percentage points on the tax rate you pay on the dividends.

Payments in lieu don't qualify for that favorable discourse and get taxed at quotidian income rates. With those rates rising as high arsenic 39.6%, payments in lieu can represent a high-priced tax problem.

How to prevent payments in lieu
There's a fashio you can make for sure you'll never have to deal with substitute payments in lieu of dividends: choose a cash securities firm account quite than a margin brokerage account. In a cash account, your broker isn't allowed to use your shares to lend to short-sellers, preventing the payment in lieu situation from coming about. By contrast, a margin account usually includes provender allowing your agent to lend your shares whenever it wants.

Substitute payments in lieu of dividends are important to income investors in that they ensure that you're getting the income you deserve. Nevertheless, the negative tax effect puddle payments in stead something to head off rather than something to embrace.

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