How will my financial institution reduce the tax impact of substitute dividend?

Different financial institutions have different policies. Some, for example, will pay accounts (other than corporate and tax-exempt accounts) that receive substitute dividend an additional credit of 30.77% of the amount of the substitute dividend to compensate for negative tax implications.

This additional credit is based on the assumption that the account owner is in the highest federal tax bracket of 35%. Giving the account owner this additional credit results in the account owner receiving the same amount after federal taxes as if the substitute dividend were taxed at 15%, i.e., the maximum federal tax rate on qualified dividends.

Note:

Financial institutions are not required by law to pay this credit. Financial institutions can, and always reserve the right to, revise this policy at any time. Also, the credit percentage can be changed or eliminated without notice.

Example:

Investor John has a margin account with a debit balance, stock is lent out and John receives a substitute dividend of $100 as a result of the random lottery. On the day John receives the substitute dividend an additional credit of $30.77 is made to John’s account. The table below compares the receipt of a substitute dividend versus a qualified dividend.