What Is the PFF Dividend Tax Treatment?
PFF distributions have a complex tax profile. This guide explains how its unique income composition impacts your tax liability in taxable and retirement accounts.
The iShares Preferred and Income Securities ETF (PFF) is an exchange-traded fund for investors seeking regular income by investing in a portfolio of preferred stocks. While the monthly distributions are attractive, their tax treatment is more complex than that of a simple stock dividend. Understanding the tax implications is important for managing one’s financial obligations and optimizing after-tax returns.
The Components of PFF Distributions
The monthly payments from PFF are composed of several distinct categories with their own tax characteristics, as the fund holds a diverse basket of securities. The exact breakdown of these components varies annually and is detailed by the fund issuer after the close of the tax year.
A portion of the distribution is classified as qualified dividends. For a dividend to be qualified, it must be paid by a U.S. or qualifying foreign corporation, and the investor must hold the shares for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Another part of the distribution is non-qualified dividends, which do not meet these criteria.
PFF distributions also include a return of capital (RoC), which is a return of the investor’s original principal. Additionally, the fund may generate capital gains distributions when it sells underlying securities for a profit. Because PFF holds securities from Real Estate Investment Trusts (REITs), a part of its dividend could be classified as a Section 199A dividend.
Federal Tax Rates for Each Distribution Type
The different components of PFF’s distributions are subject to varying federal tax rates. Qualified dividends and long-term capital gains distributions receive preferential tax treatment, with rates of 0%, 15%, or 20% depending on the investor’s taxable income. For 2024, the 0% rate applies to single filers with taxable income up to $47,025 and married couples filing jointly with income up to $94,050. The 15% rate applies for incomes above these thresholds up to $518,900 for single filers and $583,750 for joint filers, with the 20% rate applying to incomes above those levels.
In contrast, non-qualified dividends are taxed as ordinary income. This means they are subject to the investor’s marginal tax rate, which can be as high as 37%.
The tax treatment for a return of capital (RoC) is not taxed in the year it is received. Instead, it reduces an investor’s cost basis in their PFF shares. For example, if an investor paid $35 per share and receives a $1 per share RoC distribution, their new cost basis becomes $34. The portion of the distribution classified as Section 199A dividends is eligible for a 20% deduction for many taxpayers.
How to Report PFF Distributions on Tax Forms
For investors holding PFF in a taxable account, all necessary information for tax reporting is on Form 1099-DIV, sent by their brokerage firm after year-end. This form breaks down the distributions into the various categories required by the IRS.
Specific boxes on the 1099-DIV correspond directly to the distribution types discussed:
- Box 1a shows the total ordinary dividends.
- Box 1b reports the qualified dividend portion.
- Box 2a details total capital gain distributions.
- Box 3 reports non-dividend distributions, which is the return of capital amount.
- Box 5 is for Section 199A dividends.
While the 1099-DIV is comprehensive, investors can find supplementary documentation on the iShares website. This provides the precise percentage breakdown of income, which is useful for confirming the character of the distributions before filing.
Holding PFF in Retirement Accounts
The tax complexities of PFF distributions are different when the ETF is held within a tax-advantaged retirement account. The tax treatment is governed by the rules of the account itself, not the character of the income generated within it. The breakdown of distributions becomes irrelevant for annual tax filing.
In a traditional IRA or 401(k), all investment growth, including dividends and capital gains from PFF, is tax-deferred. An investor pays no taxes on the distributions as they are received each year. Instead, taxes are paid on withdrawals made during retirement, which are taxed as ordinary income.
In a Roth IRA or Roth 401(k), contributions are made with after-tax dollars. In exchange, all subsequent growth and distributions are tax-free. When PFF is held in a Roth account, qualified withdrawals taken in retirement are not subject to any federal income tax.