Margin Interest Deduction

So I was feeling like testing the waters of margin after I found that the interest can be deductible. I looked before I lept, but not well enough. The interest is only deductible from investment income. The IRS definition of this is pretty confusing, but from websites that attempt to filter through the smoke it looks like it most often means qualified dividends. Qualified dividends have  in recent years been taxed at a reduced rate - capped at something like 15%. What I was unaware of is that when you have a margin account, as opposed to a cash account, then the broker can lend your shares for short sells, and then the dividend you receive is not qualified, but a In Lieu Dividend /Substitute Payment. This type of dividend still counts as investment income[or does it? the IRS is so vague about it], however according to what I've read so far, it is not eligible for the 15% tax cap that qualified dividends are offered. Most of the information I found seemed like it was put together by someone approximately as intelligent as Aunt Bee, including the IRS site which is full of broken links, and blatantly wrong information. I'm not done with my investigation, and will try to cite the sources I've already mentioned, but I am just trying to get this new category started for now. So check back later if links aren't here yet.

here is the site claiming that In Lieu Dividends are not eligible for the 15%ish tax cap. I find this slightly hard to believe, since the type of dividend you receive is out of your control, at least pretty far removed from deciding if you want a cash or margin account.
Follow up: looks like Aunt Bee was right this time. The preferred tax rate that qualified dividends are eligible for is a fairly new rule, and I imagine the rest of the tax law simply hasn't caught up.

I still don't have a clear answer to whether or not substitute payments count as investment income which investment interest can be deducted from. Substitute payments do have a small subsection in the investment income section, which is little more than a link to a section explaining how different they are than dividends.

IRS Publication 550, Investment Income >> dividend section - "Certain substitute payments in lieu of dividends or tax-exempt interest that are received by a broker on your behalf must be reported to you on Form 1099-MISC, Miscellaneous Income, or a similar statement. See also Reporting Substitute Payments under Short Sales in chapter 4."

from the "Report Substitute Payments" sec. - "Do not treat these substitute payments as dividends or interest. Instead, report the substitute payments shown on Form 1099-MISC as “Other income” on line 21 of Form 1040."

I guess writing these tax laws actually require less work than driving a bunch of tax payers to the middle of a desert then pillaging their house before they get back.

From "Other Income" sec. -
"Bribes. If you receive a bribe, include it in your income."
also
"Illegal activities. Income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Form 1040..."

but no mention of "substitute payments" WTF

I finally called the IRS and they told me it was too complex of an issue for them to answer and that I would need to visit a CPA that specializes in this type of deduction. So, look here for an answer in the spring of 2011.

Here is a link to a really good article I finally tracked down from Aunt Bee's article,
referencing this Investment News article "A nasty surprise on dividends" , from January 26, 2004

update: After talking to a wise-ass(a tax professional) I've been advised this is a losing game. The amount of special circumstances regarding investment income classifications makes the potential deduction not worth it. Stick with the qualified dividend tax shelter and save yourself a headache.