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Annual Credit for Substitute Payments

Margin account customers may receive credit for substitute payments they received in lieu of dividends. Learn about these credits and how they may affect your federal income taxes.

If you have a margin account with a debit balance, you may have securities in your account that are eligible to be lent out to a broker. If the shares are lent over a record date, (when dividends are paid), you are generally eligible to receive substitute payments to make up for any dividends you may have missed. The borrower who received dividends typically pays this cost, which is passed back to you by your broker/dealer.

Prior to 2003, both actual dividends and these substitute payments were taxed at the federal level as ordinary income. Lower federal rates for qualified dividend income were subsequently introduced, but they do not apply to substitute payments in lieu of dividends. Therefore, these substitute payments are still taxed as ordinary income (at federal rates as high as 35% for tax year 2012, increasing to 39.6% for tax year 2013).

If you receive a substitute payment in lieu of a qualified dividend, you may qualify for an annual credit adjustment. Most brokers, including Fidelity, provide such adjustments annually to help cover any additional federal tax burden.*

Who might be eligible for the credit

You may be eligible to receive the annual credit adjustment if:*

  • You are a U.S. citizen or resident alien.
  • You received the substitute payment in an account registered as individual, joint, trust, estate, or "pass-through" entity type (partnership, LLC, LLP, etc.).
  • The account is open at the time credit adjustment is made.
  • You would have been eligible to treat (and report to the IRS) the dividend paid on the security on loan as a qualified dividend, had the security not been on loan and had you received the dividend paid on that security rather than the substitute payment in lieu of the dividend. (You will generally satisfy this condition if the applicable security is from a domestic corporation or a qualified foreign corporation, and you would have held the security unhedged for the requisite holding period for qualified dividend treatment.)

When the credits are paid

Credits for substitute payments received during the calendar year will be paid in the first half of March of the following calendar year, or as soon thereafter as all reclassification information is made available. The account receiving the substitute payment, or an eligible successor account, must be open at the time that adjustments are scheduled to be made in order to receive the credit.

How Fidelity calculates the credits

The annual credit adjustment is intended to compensate for any additional federal taxes you might have to pay. Fidelity assumes that the substitute payment is taxable at the highest federal ordinary income tax rate of 35% for tax year 2012, and the missed qualified dividend is taxable at the highest federal qualified dividend tax rate of 15%. (For tax year 2013, the highest federal qualified dividend tax rate will increase to 20% and the highest ordinary income tax rate will increase to 39.6%.)

Since the credit itself is potentially taxable, Fidelity makes a further adjustment, bringing the amount to 30.77% of the substitute payment received (for 2012 payments).

Reporting the credits on your tax return

Fidelity reports substitute payments in lieu of dividends or interest on line 8 of Form 1099-MISC.

Fidelity reports the annual credits for substitute payments you received on line 3 of Form 1099-MISC, part of your account’s consolidated tax reporting statement. The credits should generally be reported as “Other income” on your federal income tax return. Consult your tax form instructions or advisor for more information.

Additional resources

Retirement Accounts and Taxes
Learn how deductible contributions and taxable withdrawals may affect your federal income tax return.

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* The annual credit adjustment program is not guaranteed to remain in effect indefinitely, and Fidelity reserves the right to amend or terminate the program.

Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.

Before using this information, review important legal information and terms of use applicable to products, services, and/or information provided or accessed herein by the following companies:

GainsKeeper®
The use of GainsKeeper branded products is governed by Wolters Kluwer Financial Services (Wolters Kluwer) applicable license agreements. GainsKeeper and the GainsKeeper logo are registered trademarks and/or service marks of Wolters Kluwer. Wolters Kluwer is not affiliated with Fidelity Brokerage Services (FBS) or their affiliates. Wolters Kluwer is solely responsible for the information, content and software products provided by it. Fidelity does not explicitly or implicitly endorse or approve such information, content or products. Fidelity cannot guarantee that such information and content supplied is accurate, complete, or timely, or that the software products provided produce accurate and/or complete results. Fidelity does not make any warranties with regard to the information, content or software products or the results obtained by their use. Fidelity disclaims any liability arising out of your use (or the results obtained from, interpretations made as a result of, or any tax position taken in reliance on information provided pursuant to, your use) of these Wolters Kluwer software products or the information or content furnished by Wolters Kluwer.

TradeLog®
The use of TradeLog branded products is governed by Armen Computing Ltd. (Armen) applicable license agreements. TradeLog and the TradeLog logo are registered trademarks and/or service marks of Amren. Armen is not affiliated with Fidelity Brokerage Services (FBS) or their affiliates. Armen is solely responsible for the information, content and software products provided by it. Fidelity does not explicitly or implicitly endorse or approve such information, content or products. Fidelity cannot guarantee that such information and content supplied is accurate, complete, or timely, or that the software products provided produce accurate and/or complete results. Fidelity does not make any warranties with regard to the information, content or software products or the results obtained by their use. Fidelity disclaims any liability arising out of your use (or the results obtained from, interpretations made as a result of, or any tax position taken in reliance on information provided pursuant to, your use) of these Armen software products or the information or content furnished by Armen.

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