How to Report Short Dividends

If you received an IRS form 1099-MISC with a Box 8, Substitute payments in lieu of dividends or interest, this means that your broker lent out your shares to a short seller. The 'substitute payments in lieu of dividend or interest" is the short seller making you whole for the dividend collected while he held the stock. 

Substitute payments in lieu of dividends or interest do not qualify for favorable tax rates on qualified dividends.  The payment will not offset dividend income.  The payment will be reported as other income on line 8z on Schedule 1 Additional Income and Adjustments to Income.

@JohnB5677 here says you may be able to report the income as a self-employment activity with expenses charged against the income.

When you run through the questions, you will come to a question about whether you intended to make money. If you did intend to make money, then it will tax your money as a business and apply the Self-Employment Tax. You can then deduct your expenses if you have any. If you did not intend to make money, then the program will just add the income as ordinary income with no Self Employment Tax.

@MAC18 

I did not receive dividends.  I paid dividends because I was short a stock that paid a dividend.  I believe the correct treatment is for TurboTax to add the dividends I paid to the cost of closing out the position.  However, TurboTax is not doing this.  It is not doing anything with the paid dividends.  Is it possible to manually change the cost to close out the short position in TurboTax?  The purchase and sales data was imported to TurboTax form the brokerage 1099.

see Pub 550 section on Reporting Substitute Payments for how to handle it.

@MAC18 

The instructions in Pub 550 say that I am suppose to add the dividends to my basis when the short position is closed.  However, TurboTax is not doing this.  How can I manually increase my basis in the stock in TurboTax so that I properly report the correct gain?  The 1099-B info was imported so I did not enter everything manually.

Assuming you held the short position open for more than 46 days, you are correct in that you can add the dividends you paid to your cost basis.  To make a manual adjustment to your cost basis, go back to the Investments and Savings section (TurboTax online) or Investment Income (TurboTax CD/download) and select Revisit/Update.  Find the short position you want to adjust, and select Edit.  

If you are using TurboTax online, you will see another screen with a pencil icon near the trash can icon.  Select the pencil icon, and don't make any adjustments--just select Continue-- until you get to the screen, Adjust your cost basis to ensure best outcome.  Then select I found my adjusted cost basis and enter your adjusted cost basis.  If your basis does not update, then go back to the screen containing your original cost basis and adjust it there.  Keep your records to support the adjustment you made.

In TurboTax CD/download, the process is essentially the same.  However, when you see the screen, Select any less common adjustments that apply, select the last option.  Follow the instructions and make your adjustment.  Your basis will be updated to reflect the dividends you paid.

@MAC18 

Thank you George.  How are the short dividends treated if the short position was open for less than 46 days?

If it is held for less, then the short dividends are characterized as an investment expense.  They are deductible, but only if the taxpayer can itemize their deductions.  

@MAC18 

Did you have it reported on a 1099 or on a Supplemental Details (not reported to IRS)?  My short dividends do NOT show up on my 1099, just in the supplemental information sheet.

George, I think you may have this backwards. It sounds like the dividends are added to my basis only if I held the position 46 days or less (which is the case for me).  My 1099 did not do this so I need to do it manually in TurboTax.  Here is the language from IRS Pub. 550 regarding the treatment of dividends the investor pays while being short a dividend paying stock:

Yes, my short dividends were reported on my 1099.  However, they were not added to my basis so I needed to manually adjust my basis in TurboTax.

See the Instructions for Form 8949 for how to use Code "B" and whether you need an amount in column (g).

TurboTax supports this.

@MAC18 

How is this supported by the TurboTax?

Do you mean checking the box for the sale transaction where it says that the Cost basis is incorrect and entering a different (adjusted) cost basis?

Also, is it indeed the case that such adjustment could be made for the dividends paid short?

I am wondering because Pub 550 says:

"If you close the short sale by the 45th day after the date of the short sale (1 year or less in the case of an extraordinary dividend), you cannot deduct the payment in lieu of the dividend you make to the lender. Instead, you must increase the basis of the stock used to close the short sale by that amount."

but then

"Exception.

If you close the short sale within 45 days, the deduction for amounts you pay in lieu of dividends will be disallowed only to the extent the payments are more than the amount you receive as ordinary income from the lender of the stock for the use of collateral with the short sale. "

What does the Exception mean? It does not seem to make sense since if you close the short sale within 45 days, you can't take a deduction, period. You are directed to adjust the cost basis.

So, can I add the dividend amount to the basis if I closed the short sale in under 45 days or not? I did not receive any payments from the lender of the stock (i.e., from my broker) for its use. Does anyone get such payments?

Based on Pub 550, I added the dividends I paid while being short to the cost basis of my short position.  This reduced my realized gain by the amount of the dividends I paid.  I held my short position for less than 45 days.

I am in the exact same situation. RH reported me that I paid dividends and withheld foreign tax on the dividends I paid, but they didn't adjust the basis of my short sell. Do I supposed to go in the transaction and increase my basis? How do I report the foreign tax associated with the dividend I paid? Please help!

How do I report the foreign tax associated with the dividend I paid? My 1099-B show that I paid dividends on my short sell and withheld tax on it. Do I suppose to reduce the dividend paid by the amount of the foreign tax? and then add this amount to my basis? RH didn't adjust my basis that reported to the IRS. 

To clarify, is your 1099B a consolidated statement that has a 1099 DIV section within the statement that reports this dividend?

@VickyD10

Hi Dave,

The 1099-DIV did not show any dividends that I should report, it is Zero. However, it shows a negative amount of foreign tax. In summary, RH recorded that I paid dividends (not received) and the foreign tax associated with the dividend I paid. 

To clarify, under the Reconciliations, Fee and Expense (The amounts in this section are not reported to the IRS) They are presented here for your review reference when preparing your income tax return), RH shows:

Fee & Expenses - Dividends paid on short position          $10K

And nothing else.

Under Dividend & Distribution (1099-DIV)

Line 1 a, b Dividend                           $0

Line 7- Foreign Tax Paid                   - $2.5K

It depends. I am not sure why this is reported but I would ignore it as this Turbo Tax article states. As one of the users stated, this is informational to you because because the tax paid is a subtraction from your account balance.

Since there are no dividends reported on the 1099 DIV, then you would not report the 1099 DIV on your return.

Unfortunately , you would not be able to claim the fee and investment expenses on your return because investment expenses are no longer deductible because of 2018 Tax Cuts and Job Acts.

Hi,

Bottom line, because I did a short sell, RH indicated in the information section that I paid $10K of dividends and received $2.5K foreign tax (negative 2.5K tax paid), they did not adjust the basis of my transaction so that RH reported a gain to the IRS. My original question was, do I report an adjustment basis of 7.5K (10K-2.5K) in Turbo tax for the stock transaction, so that it will reflect the correct amount of gain and loss that should be reported to the IRS. RH had reported a gain, I had the loss instead. 

No. This is not the proper procedure to report this. You would need to claim a foreign tax credit for the amount of the foreign taxes paid. Here is how to enter.
 

1. Go to Federal
2. Deductions and credits 
3. Estimate and other taxes paid 
4. Foreign Tax Credit>start or revisit
5. When it asks We just need to check if you have any uncommon situations indicate I paid foreign taxes on income I earned while working in another country. 
6. Navigate and record the entries that the program asks for and when you reach the page that mentions Foreign Tax Credit Worksheet, this is where you take notice.
7. The first that you will be asked is what category of income is it, you will say Passive income.
8. Next screen will say Country Summary, select add a country 
9. When it says Other Gross Income - XXXX, Here you put in the Gross Amount you earned in that country. 
10. Then you will navigate through the screens until you come to a screen that says Foreign Taxes Paid - XXXX, here is where you record the amount paid under Foreign Taxes. ($2.5K)
11. Don't report this as a negative number.
12. Finish out the section.

Thanks so much for your help. 

I also want to clarify that I should enter a loss, thus under the Passive Income/ Gross amount / negative 10k? As I stated previously RH indicated that I paid 10k dividends. Please advise if you think I should do differently.