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Information-reporting guidance for payments in lieu of dividends.

Notice 2003-67 offers guidance to brokers and individuals on provisions in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) that affect information reporting for payments in lieu of dividends, effective Sept. 16, 2003.


For tax years beginning after 2002 and before 2009, JGTRRA Section 302 reduces the tax rate for "qualified dividends" paid to individual shareholders to the capital gain rate. (For this purpose, "qualified dividends" do not include (1) "extraordinary dividends," (2) dividends with respect to certain foreign corporations and (3) certain dividends paid by mutual savings banks or on employee stock ownership plan securities.)

The reduced rate does not apply to a dividend on stock held by the taxpayer for 60 days or less of the 120-day period that begins 60 days before the ex-dividend date. Further, the reduced rate does not apply to the extent the taxpayer is obligated to make related payments (e.g., payments in lieu of dividends) for positions in substantially similar or related property.

The legislative history states that payments in lieu of dividends are not eligible for the reduced rate. Additionally, the Conference Report provides that the conferees intend for the IRS to exercise its authority under Sec. 6724(a) to waive penalties when brokers and dealers attempt in good faith to comply with the Secs. 6042 and 6045 information-reporting requirements, but are unable to reasonably do so because of the time needed to conform their information-reporting systems to the retroactive rate reductions on qualified dividends; see H. Conf. Rep't No. 108-26, 108th Cong., 1st Sess. (2003), pp. 42-43.

Penalty Waiver

Under Notice 2003-67, brokers who, in the normal course of a trade or business, engage in securities-lending transactions, short sales or other similar transactions for customers, are expected to immediately undertake action to conform their information-reporting systems to the JGTRRA. Brokers should complete their efforts to comply with the JGTRRA as soon as reasonably possible for calendar-year 2003 and, to the extent reasonably possible, to comply with their reporting responsibilities in a manner consistent with JGTRRA for payments in lieu of dividends for calendar-year 2003.

Notice 2003-67 states that the Service will exercise its authority under Sec. 6724(a) to waive penalties if the broker shows that it made a good-faith attempt to comply with the Secs. 6042 and 6045 information-reporting requirements in a manner consistent with the JGTRRA for dividend payments made during calendar-year 2003, but could not reasonably do so because it had inadequate time within which to conform its information-reporting systems to the JGTRRA.

For calendar-year 2003, the Service will consider all of the facts and circumstances in determining whether a broker acted in good faith. However, for calendar-year 2004, the Service will consider brokers to have had adequate time to conform their information-reporting systems to the JGTRRA for payments in lieu of dividends.

Form 1099-MISC and Rev. Proc. 2003-28

The Service has revised the instructions to Form 1099-MISC, Miscellaneous Income, for calendar-year 2003 payments in lieu of dividends. Brokers must report payments in lieu of dividends in Box 8 of Form 1099-MISC, regardless of whether the recipient is a corporation, an individual or another type of taxpayer. The Service also plans to revise Rev. Proc. 2003-28 to allow brokers to provide composite substitute payee statements for Forms 1099-DIV, Dividends and Distributions, and 1099-MISC, reporting payments in lieu of dividends.

Payments Reported on Form 1099-DIV

For calendar-year 2003, an individual who receives a Form 1099-DIV that improperly characterizes payments in lieu of dividends as dividend income may treat the payments as dividend income to the extent they are reported as dividend income on Form 1099-DIV, unless the individual knows (or has reason to know) that the payments are in fact payments in lieu of dividends, instead of actual dividends.

Amendments to Regs. Sec. 1.6045-2

The Service intends to amend Regs. Sec. 1.6045-2 to reflect the JGTRRA's differential tax treatment for dividends and payments in lieu of dividends, effective for dividends received after 2002. Under the current regulations, brokers must allocate transferred shares between shares of stock (l) the broker borrowed under a securities-lending agreement with the customer (borrowed shares) and (2) held by the broker on behalf of customers who have authorized it to loan their shares to third parties (loanable shares). Regs. Sec. 1.6045-2 currently provides that transferred shares be allocated first to borrowed shares and then to loanable shares, to the extent the number of transferred shares exceeds the number of borrowed shares.

The Regs. Sec. 1.6045-2 amendments will clarify that loanable shares do not include shares the broker is prevented from lending by law. The amended regulations also will permit brokers to exclude from loanable shares one or more of the following categories:

1. All shares held for the broker's own account;

2. All shares that would not be loanable but for the fact they are held in a margin account under account documentation authorizing share lending;

3. Shares that the owner has requested the broker not to lend;

4. Shares that had been loaned, but for which the owner exercised a right under the lending agreement to call back within a fixed period; and

5. Any other category of shares described in IRS guidance.

The amended regulations will provide that shares in any of the categories may be treated as not loanable only if (1) at the time the broker designates the share as not loanable, the share has not been loaned under an outstanding loan agreement; (2) the designation of a category of shares as not being loanable is reflected in a written broker policy placed in its books and records on or before the time of the stock loans to be affected by the policy; and (3) the policy is consistently applied for both tax and nontax purposes to all shares described in the category.

In addition, the amended regulations will allow brokers to use a new hierarchical method to allocate transferred shares. Under this method, brokers will have to allocate transferred shares in the following order:

1. Shares borrowed under a securities-lending agreement;

2. One or more pools of shares held by tax-indifferent customers to the extent of loanable shares in those pools;

3. A single residual pool of all other loanable shares.

If only a portion of the loanable shares held in a pool are transferred, the broker must allocate the transferred shares among customers in the pool using the random lottery method provided in Regs. Sec. 1.6045-2(f)(2)(ii)(B). A broker may use another allocation method only with the Service's consent.


The Service has recognized that brokers may not be able to modify their systems in time properly to report to shareholders the amounts of substitute payments made in 2003. However, it is still unclear what "good faith effort to comply" means. Presumably, brokers cannot do nothing and expect to have penalties waived. The most logical meaning is that brokers must have begun to put in place a JGTRRA reporting process by the end of 2004, assuming it would not be reasonably possible to implement one by the end of 2003. This will involve having systems in place at the beginning of 2004 that will be able accurately to track information on substitute payments as they occur during that reporting year, for inclusion in Forms 1099 to be sent out in 2005.

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Article Details
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Author:Levy, Marc
Publication:The Tax Adviser
Date:Jan 1, 2004
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