The new system for taxing dividends has caused serious disruptions for investors and accountants trying figure out which dividends qualify for lower tax rates. The American Institute of Certified Public Accountants says it is the biggest headache facing their members this year.
"There's a lot of people tearing their hair out," said Tom Ochsenschlager, the organization's vice president of taxation.
Congress last year cut taxes on some dividends paid by stocks and mutual funds. The change applied to dividends paid since January 2003. Taxes on certain dividends were lowered to no more than 15 percent.
Dividends that do not qualify for the lower rates can be taxed at regular income tax rates as high as 35 percent. Dividends still taxed at the higher rate include money distributed by preferred stocks, real estate investment trusts and some foreign companies.
Brokers scrambled to reprogram their computers to reflect the new law.
Bill Lazor thought he had a jump on the busy tax filing season when he prepared a tax return in January for a client who had received dividends on stock held in a brokerage account.
Lazor, an accountant at Kronick Kalada Berdy & Co. in Kingston, Pa., said the client's tax statement showed the dividends did not qualify for the new 15 percent tax rate enacted last year.
Then the client returned in February with a corrected tax statement that reclassified the dividends. They now qualified for the lower rate.
Lazor dutifully prepared an amended tax return and sent it to the Internal Revenue Service.
But his client returned in March with a second corrected tax statement that showed the dividends were not dividends at all. The money counted as interest and did not qualify for the special dividend tax rate.
"At that point I just threw my hands up," Lazor said. "It just gets to be ridiculous."
The Securities Industry Association asked the IRS to extend the deadline for mailing tax statements to investors to give companies more time to refine their dividend reporting calculations. The IRS denied the request, arguing that taxpayers expecting a refund would have to wait longer to claim their money.
Some securities and brokers have had to send corrected tax statements after finding errors in their original calculations. Mutual funds, which report multiple kinds of dividends, faced the most complicated calculations.
Rick Hollingsworth, manager of tax information returns at H&R Block Financial Advisors, said 25,000 securities faced complicated dividend calculations. The securities industry expects to send three times to five times more corrected forms than usual, he said.
Another return to file?
Taxpayers who already filed a return, only to find a corrected tax statement in the mailbox later, may wonder whether they have to file an amended return using the new information.
The answer is probably yes, said IRS spokesman Don Roberts.
When a correction means that a taxpayer owes more money to the government, the taxpayer must file an amended return using Form 1040X. The amended return must be sent by April 15 for the taxpayer to avoid paying interest on the extra taxes owed.
When a correction means that a taxpayer overpaid and deserves a refund, it is up to the taxpayer to decide what to do.
"In either case, they should file an amended return -- in one case because it's extra money in their pocket, in the other case because they owe the tax," Roberts said.
Tax professionals can prepare amended returns or individuals can use the information from their original return to prepare the amended return themselves. Most home software packages allow taxpayers to prepare amended returns, but the new return must be printed out and mailed to the IRS. The tax agency cannot accept amended returns filed electronically.
Daunted by the idea of sending two returns in a year, some taxpayers choose not to file amended returns, Ochsenschlager said.
"If a client doesn't choose to file the amended return, I guess we can't force him to do it," he said. "If the person just did nothing, chances are very high that the IRS will pick up on it."
The IRS matches information reported on an individual's tax return with documents submitted by employers, banks and brokerage firms. If the IRS finds that the taxpayer neglected to pay all the taxes owed, it sends a notice and charges interest on unpaid taxes.
Taxpayers are cautioned by the IRS not to rely on it to fix the problem. It can be a year or more before the IRS gets around to correcting the tax calculation and sending the bill for taxes due, plus interest.
The tax agency doesn't send a check when document matching finds the taxpayer should have gotten a bigger refund.
"You have to claim a refund," Roberts said.