Introduction to payments in lieu of dividends (PILs)

Introduction to payments in lieu of dividends (PILs)

According to your client's account agreement, Schwab may borrow securities from accounts carrying a margin loan balance or from accounts enrolled in the securities lending fully paid program and lend them to other investors. If Schwab loans these securities to another party, over a record date Tooltip , your client is eligible to receive a payment in lieu of dividend (PIL).

PILs are "substitute payments," made by Schwab, to make up for dividends your client may have not received. These payments are treated as ordinary income Tooltip and are not eligible for the lower "qualified" dividend rate because, they are issued in substitution of an "actual" dividend from the borrowing corporation or transfer agent.

Key information related to PILs:

Criteria
Clients may receive a PIL from Schwab if all of the following conditions apply:

  • The client has an outstanding margin debit balance.
  • The client’s account includes dividend-paying securities.
  • Schwab has loaned one or more of their dividend-paying securities to another investor.
  • The securities are loaned on the dividend record date.

Clients will not receive a PIL from Schwab under the following conditions:

  • They do not carry a margin balance.
  • They have a margin balance, but do not hold dividend-paying securities in the account.

Allocation
Schwab allocates PILs to accounts according to the lottery allocation system, authorized by the IRS. This means that Schwab randomly allocates PILs among a pool of eligible clients.

Minimizing PILs
Schwab attempts to minimize the number of clients who receive a PIL, through the restriction of new loans and short sales of some dividend-paying securities around record date, or by borrowing back stock over the record date. You can also work with your client to avoid the eligibility conditions for the PIL candidate pool.

Tax rate
PILs, also known as "substitute payments," are not eligible for the favorable 15% tax rate offered to qualifying dividends; instead, they are treated as ordinary income.


Schwab reports PILs as a "substitute payment" on Form 1099-MISC included in the Form 1099 Composite. 

Statement notices

  • PILs are described in the Transaction Detail section of the Schwab statement as "substitute inc pmt." A footnote also appears in the Income Summary of the Cash Dividends line: "Amounts reported as cash dividends in the income summary may include substitute payments in lieu of income."
  • Substitute income credits are described in the Transaction Detail section of the statement as "Schwab substitute income credit."

Substitute income credit
Schwab makes an additional credit payment (referred to as a “Schwab credit” or “gross-up payment in lieu”) of 27% of the PIL into a client's account if they have experienced adverse tax effects Tooltip due to receiving a PIL. This credit is a goodwill gesture Tooltip to compensate the client for paying a higher tax rate on a PIL than they would have on a qualified dividend. In most cases, Schwab credits the account on the same day the PIL is made.

Substitute income credit tax reporting
These credits are subject to both your client’s ordinary income tax rate and to federal tax rates. Schwab reports credit payments to the IRS on the Standalone Form 1099-MISC form under the following conditions:

  • The total of the PIL credit and any other miscellaneous credits equals $600 or more.
  • Or, if the Tax Equity and Fiscal Responsibility Act of 1982 withholding was applied to any portion or the credit total.

Substitute income credit consequences
There may be unintended consequences for clients who receive a credit payment. For example, it may increase their adjusted gross income (AGI), adversely impacting itemized deductions, exemptions, and IRA contributions. This creates a potential for a tax-rate increase.

Because of these potential consequences, your client can choose not to receive the credit. To reverse the credit, you must call your service team each time they receive a credit.

The following are available to assist you:


Introduction to tax forms
Tax form reporting
How to enroll clients in securities lending fully paid (SLFP) program
Introduction to margin

Participants should consult with their tax advisor if they have any questions about tax implications.

Refer to the Loan Consent section of the Account Agreement regarding Schwab’s right to loan securities as described in this article.

For more information about substitute income credits, refer to the Credit Payment Fact Sheet.

Learn more about PILs at irs.gov or by calling your relationship manager.