IB and tax advantaged distributions

R

rayl

A word of caution:

If you hold a security making a tax advantaged distribution (e.g., a tax free distribution) at IB, it appears that IB does not insure that the security is not loaned out on its ex-date -- so you may end up getting a payment in lieu of dividend (which is not tax-advantaged) instead!

I admit that I never researched this. Other brokerage accounts I have, I noticed, keep such securities journaled as Cash instead of Margin, presumably to avoid this.

Sigh. I think this is the first case where I've seen a serious shortcoming in the way IB does things. Now I gotta move these positions out of IB.

I had this happen w/a tax free distribution. In theory it can also happen with long term cap gains from ETFs.... I will move those out come December just in case as well.
 
The more I think about this -- it's a risk for ordinary qualified dividends as well! (15% rate vs higher rate) though it ahsn't happened to me yet. Sigh. I guess the risk is larger for larger distributions, so one should plan accordingly. I'm now thinking of opening a 2nd cash account as a solution though presumably I would end up paying the $10/month inactivity fee on it.
 
Credit where credit is due:

Though cust svc responded saying that any margin account, even if not in debit at the time, can have any security loaned out, IB reversed my PIL and credited a regular dividend.

While I appreciate the change, in the absence of a clearly stated policy on how to minimize or compensate for the risk (some brokers will take a loss on lending proceeds and mark your positions to cash on the record date, others will get you some additional payment on top of the dividend), I am still uncomfortable holding either higher yielding or tax free securities in an IB margin account.
 
I think all margin accounts have a "rehypothecation" agreement allowing the broker to lend your stock. I believe they receive payment for such loans. I've never had to pay a "stock loan fee" when I carried a short overnight. I guess the borrowing broker makes up for the fee by the interest earned on the credit balance credited by the short sale.

How would a broker figure out how much to pay you for the loss of a "qualified dividend"? You would lose the 15% flat rate but where would you fit in the income tax structure - 10%, 15%, 25%, 28%, 33% or 35%?

An interesting problem. The easy answer is loaning stock from a tax protected account like an IRA where there is no tax on the transactions inside the account. The problem with that approach is they are cash accounts and do not have the rehypothecation agreements.

Jack
 
Quote from JackR:

I think all margin accounts have a "rehypothecation" agreement allowing the broker to lend your stock. I believe they receive payment for such loans. I've never had to pay a "stock loan fee" when I carried a short overnight. I guess the borrowing broker makes up for the fee by the interest earned on the credit balance credited by the short sale.

How would a broker figure out how much to pay you for the loss of a "qualified dividend"? You would lose the 15% flat rate but where would you fit in the income tax structure - 10%, 15%, 25%, 28%, 33% or 35%?

An interesting problem. The easy answer is loaning stock from a tax protected account like an IRA where there is no tax on the transactions inside the account. The problem with that approach is they are cash accounts and do not have the rehypothecation agreements.

Jack
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Some of my other brokers would rather screw the borrower and call in the shares on the record date. For many nonprofit institutionals, this is a non-issue and is the first source of shares to borrow. Others (including one payment-for-order-flow broker I use) will give you something -- I've found it varies, but it's usually about 20-30% more. It isn't guaranteed though but is a stated policy to try.

This case was particularly egregious as it was a TAX FREE dividend. Actually at no other broker has this happened with a tax free CEF or a year end ETF cap gains distribution in the past 15 years I've been in the market.
 
IB could probably write a simple (if there is such a thing given their system) algorithm to review all holdings of the stock within their purview. On the eve of the ex-dividend date transfer the stock loan to an account that holds the loaned stock but that does not hold it as a "qualified" issue. Some accounts will qualify on the ex-dividend date, others will qualify within an additional X days. IB could assign the loan to the account(s) with the least probability of qualifying. Actively traded accounts could also be tagged as an added probability factor.

Since we have no clue what IB does other than show the stock on our statement we'd never know of the transfer.

This would probably fix the problem in most instances. It would probably affect only actively traded accounts. Because you must hold a stock for at least 61 days of a 120-day period and the period begins 60 days before the day a stock trades ex-dividend and ends 59 days after the ex-dividend date, probably few swing readers would qualify for the 15% rate.

I guess there are also people that play the "capture the dividend" game but I doubt that they would meet the qualification window either.

IB would have to weigh the cost of creating the system, as well as the cost of running it.

I'm sure you use IB for the value you get. As you implied in an earlier post, you'll probably have to do a trade-off analysis to see what you do and don't do with IB.

Jack
 
I agree that the problem is eminently solvable as others have solved it, and it probably isn't that much cost either for the short crowd can't be choosers sometimes. Just pointing out that IB has not yet chosen to solve the problem and that's a legit risk.

I don't know about most people, but I employ a variety of strategies and was hoping to eventually consolidate most of holdings at IB as IB appears to be generally best-of-breed in my book, but, this is a limitation that prevents that from happening.

But fair is fair -- I was credited for this instance as I was surprised by the egregiousness of receiving a taxable payment for a tax exempt payment.
 
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