The Act extends the 15% (or 5%) maximum net long-term capital gains tax rate to dividends received from corporations. The 15% (or 5%) maximum rate applies to dividends received by individuals, trusts, and estates that are included in income in tax years beginning after 2002 and before 2009 (in 2008, a zero rate will apply to dividend income otherwise eligible for the 5% rate).

The Act does not change the definition of a dividend (i.e., generally a distribution with respect to a corporation's stock from its earnings and profits), and all the tax rules defining "stock" are taken into account.

Dividends paid on both common and preferred stock qualify. However, a dividend generally is not eligible for the 15% (or 5%) rate if the stock is held for 60 days or less. More specifically, the stock must be held for more than 60 days during the 120-day period beginning 60 days before the date the stock becomes ex-dividend with respect to the dividend; a longer holding period may apply to certain preferred stock dividends or if the shareholder's risk of loss is protected. Also, a dividend is not eligible for the lower rates if the shareholder has an obligation to make related payments on certain other property -- for example in a short sale.

The reduced rate applies to dividends from a:

• Domestic corporation

• Foreign corporation if its stock is readily tradable on an established U.S. securities market

• Foreign corporation that is incorporated in a possession of the United States

• Foreign corporation that is eligible for benefits under a comprehensive income tax treaty with the United States which the Secretary determines is satisfactory for this purpose, and that includes an exchange of information program

Notwithstanding these rules, the reduced rate does not apply to dividends paid by a foreign corporation that in the current or preceding tax year was a foreign investment company, a passive foreign investment company, or a foreign holding company.

Under prior law, U.S. taxpayers receiving dividends from foreign corporations could be allowed a credit for foreign taxes paid on such dividends. The Act reduces the foreign tax credit allowed against U.S. taxes imposed on dividends eligible for the reduced rate.

Dividends from an entity (including a farmers' cooperative) that is tax-exempt in the year of the distribution, or the prior year, do not qualify. Amounts characterized as "dividends" on deposits from certain financial institutions and dividends paid on certain employer securities in a retirement plan are not eligible for the 15% (or 5%) maximum rate.

In limited circumstances, dividends received from regulated investment companies (RICs), such as mutual funds, and real estate investment trusts (REITs) may be eligible for the 15% (or 5%) rate when taken into income by a non-corporate shareholder. If less than 95% of certain gross income of the RIC or REIT consists of qualifying dividend income, the entity must designate the amount of its dividends to which the shareholder can apply the 15% (or 5%) maximum rate. Dividends received by a RIC or REIT before 2003 but distributed to its shareholders in 2003 or later are not eligible for the reduced rate.

The Act provides that if an individual receives an extraordinary dividend, any loss on the underlying stock is treated as a long-term capital loss to the extent of the dividend. An extraordinary dividend is, generally, one whose amount exceeds 10% of the shareholder's basis in the stock.

As under the prior-law maximum rate provisions for capital gains, dividends are not eligible for the 15% (or 5%) rate to the extent the taxpayer elects to treat them as investment income for purposes of determining the deductible amount of investment interest expense.

The 15% (and 5%) maximum tax rates also apply in computing alternative minimum tax (AMT).

The Act does not change the treatment of dividends received by corporations. A corporation is eligible for a deduction equal to 70%, 80%, or 100% of certain dividends received from other corporations, depending on the source and ownership interest in the payor. However, the Act reduces the accumulated earnings tax and personal holding company tax imposed on certain corporate earnings to 15%, and repeals the collapsible corporation rules, effective for tax years beginning after 2002.

The changes to the maximum tax rate on dividends apply for tax years beginning after 2002 and before 2009. Thus, in 2009, the law reverts to a maximum rate of 35% on dividends.