An amount in Box 8 of Form 1099-MISC is a substitute payment in lieu of dividends or interest: cash your broker passed to you in place of a real dividend or interest payment because your securities were on loan to another party on the record date. It spends like a dividend, but the IRS taxes it as ordinary income, which almost always means a higher bill than a normal dividend would have produced.
Why You Received a Substitute Payment
If you hold securities in a margin account, the agreement you signed when you opened it typically lets the brokerage lend your shares to other traders. The usual borrower is a short seller, who sells the borrowed stock hoping to buy it back cheaper later. While your shares are out on loan, the company issuing any dividend pays it to whoever holds the shares on the record date, and that is no longer you.
To make you whole, the borrower (through the broker) sends you a cash payment equal to the dividend. That is the Box 8 amount. Federal law requires your broker to identify these payments in writing so the character of the income is clear.1Office of the Law Revision Counsel. 26 USC 6045 – Returns of Brokers The same mechanic applies to bonds: interest that accrues on a lent-out bond comes back to you as a substitute payment in lieu of interest, and this includes interest on tax-exempt bonds like municipals.
Why It Costs You More Than a Normal Dividend
A qualified dividend from a U.S. corporation is taxed at long-term capital gains rates of 0%, 15%, or 20% depending on your taxable income. A substitute payment in lieu of that same dividend does not qualify. The IRS explicitly lists payments in lieu of dividends among the dividends that are not qualified, even when the underlying stock would have paid a qualified dividend if you had held it directly.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Instead, the payment is taxed at your ordinary rate. For an investor who would otherwise pay 15% on a qualified dividend but sits in the 32% ordinary bracket, $10,000 in substitute payments produces an extra $1,700 in federal tax.
The damage is worse for tax-exempt bonds. If your broker lends out a municipal bond, the interest equivalent you receive is fully taxable ordinary income even though the real interest would have been tax-free. There is no exception.
Foreign holdings take a third hit. Dividends from foreign companies usually come with foreign tax withholding that U.S. taxpayers can offset with a foreign tax credit. That credit is not available on substitute payments; the IRS disallows the credit on dividends to the extent you have to make related payments on substantially similar property.3Internal Revenue Service. Topic No. 856, Foreign Tax Credit You can deduct the foreign taxes on Schedule A instead, but a deduction is worth less than a dollar-for-dollar credit.
How to Report Box 8 on Your Return
Treat the Box 8 amount as ordinary income. Because it replaced a dividend, it is reported as an ordinary (non-qualified) dividend, which means it belongs on Form 1040 line 3b with your other ordinary dividends, not on line 3a with qualified dividends.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses If your ordinary dividends and interest together exceed $1,500, you also need to itemize the amounts on Schedule B.
Do not leave it off. The IRS receives your 1099-MISC electronically and runs automated matching against your return. An omission can bring an accuracy-related penalty of 20% of the underpayment on top of the tax and interest owed, and the IRS names failure to report income shown on an information return as an example of negligence.4Internal Revenue Service. Accuracy-Related Penalty
How to Stop Getting Them
The cleanest fix is to keep your broker from lending your shares at all. A few options:
- Use a cash account instead of a margin account. Brokers can lend shares under the hypothecation agreement that comes with margin; in a cash account, your shares generally cannot be lent without your explicit permission.
- Opt out of fully paid securities lending programs. Many firms run these for cash-account holders and share a slice of the lending revenue. Participation is typically opt-in, and you can decline or withdraw by contacting your broker.
- Hold dividend-paying stocks in an IRA or 401(k). Retirement accounts are generally not the source of taxable substitute payments to you, because the account itself is tax-deferred.
Some brokers try to avoid lending shares before big dividends, and a few offer a credit to compensate for the tax disadvantage. Neither is guaranteed. If you have significant dividend-paying holdings in a margin account and have not read the lending provisions of your brokerage agreement, you may already be getting substitute payments and will only find out when the 1099-MISC lands in January.
Corporate Accounts Are Not Exempt
Most 1099-MISC boxes do not apply when the recipient is a corporation. Box 8 does. The IRS defines “customer” for this box to include individuals, trusts, estates, partnerships, associations, companies, and corporations, and excludes only tax-exempt organizations, the U.S. government, state governments, U.S. territories, and foreign governments.5Internal Revenue Service. Instructions for Forms 1099-MISC and 1099-NEC If you run investments through a corporate account, expect the same form for the same reason.