Covered Call Writing and Favorable Dividend Tax Treatment Go Together

You can earn more income from stock ownership through covered call writing.

Provided the call written is a “Qualified Covered Call”, qualifying dividends received on the underlying stock remain eligible for the 15% maximum tax rate on dividends.

Other writes involving a nonqualified call may cause the dividends to be taxed at ordinary income rates.

What is a Qualified Covered Call?

Covered Call option writing simply means selling a call option while simultaneously owning the underlying stock.

Generally, a covered call option is qualified if it has more than 30 days before its expiration date and is out-of-the-money, at-the-money or not “deep-in-the-money”.

The IRS has a set of regulations for determining when an in-the-money option is or is not qualified based on the stock price, time to expiration and lowest acceptable strike price.

Caution:

Writing a covered call that is not a qualified covered will cause dividends received on the underlying stock to be ineligible for the 15% maximum tax rate on dividends and have other negative tax consequences.

Take-Away:

• Care must be taken when writing in-the-money covered options to make sure they are not considered “deep-in-the-money” to retain the favorable dividend tax treatment.