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- How are dividends taxed?
- How do I know if my dividends are qualified or not?
- How much tax do you pay on dividends?
- How can you avoid paying taxes on dividends?
- What is a dividend reinvestment plan (DRIP)?
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- Dividends from stocks or funds are taxable income, whether you receive them or reinvest them.
- Qualified dividends are taxed at lower capital gains rates; unqualified dividends as ordinary income.
- Putting dividend-paying stocks in tax-advantaged accounts can help you avoid or delay the taxes due.
When you invest in a company by purchasing individual stocks, mutual funds, or exchange-traded funds (ETFs), you may be rewarded with dividends. A dividend is a per-share portion of the company's profits that gets distributed regularly to its stockholders – sort of like a quarterly bonus.
Like most other types of investment income, the IRS deems dividends to be taxable. However, not all dividends are treated — or taxed — equally. Here's everything you need to know about paying taxes on dividends. A dividend is a payment made to a company's stockholders. Business and financial entities like publicly traded companies, master limited partnerships, and real estate investment trusts issue dividends as a means of distributing their after-tax earnings to investors. Mutual funds and exchange-traded funds pay dividends as well. Determined by a company's board of directors, dividends are calculated on a per-share basis. Usually, they're in the form of cash and deposited directly into an investor's financial account. However, companies sometimes pay dividends with new shares of stock. And, in some cases, companies offer dividend reinvestment programs (DRIPs) that allow investors to apply the dividend toward the purchase of additional stock, often at a discounted price. In the US, companies usually pay dividends each quarter. But payments can also occur monthly or semi-annually. A variety of unearned or passive income (as opposed to income from your work or job), dividends are subject to both federal and state taxes. For tax purposes, dividends are classified as either qualified or unqualified, depending on how long you hold the underlying shares in a US corporation or a qualifying foreign corporation. What's the difference? Qualified dividends meet a special holding period. That means you owned the stock issuing them for at least 60 days during the 121-day period that started 60 days before the ex-dividend date. The ex-dividend date is the day after the cut-off date (aka the "record date") the company uses to determine which shareholders are eligible to receive the dividend. Yeah, that definition is pretty confusing. So here's a real-life example, sort of a timeline. TurboTax Deluxe On TurboTax's website Perks Tell TurboTax about your life and it will guide you step by step. Jumpstart your taxes with last year’s info. Fees $39 federal fee, plus $39 per state Pros Cons Product Details Why do dividends being qualified or unqualified matter? Because it affects the amount of tax you pay on them. Unqualified dividends are taxed at your ordinary income tax rate – the same rate that applies to your wages or self-employment income. So, if you fall into the 32% tax bracket, you'll pay a 32% tax rate on all your unqualified dividends, also known as ordinary dividends. Qualified dividends get preferential treatment. You pay the same tax rate on qualified dividends as you do on long-term capital gains. Depending on your tax bracket, this rate can be a lot lower than your ordinary income rate. The exact rate you pay depends on your filing status and total taxable income for the year. Returning to the IBM example above, let's assume you fall into the 32% tax bracket for ordinary income and the 15% tax bracket for long-term capital gains. If your IBM dividends are unqualified, you'll pay roughly $52 in taxes on your $163 of dividends. But if those dividends are eligible for qualified tax treatment, you'll pay only $24 in taxes. There are a few legitimate strategies for avoiding or at least minimizing the taxes you pay on dividend income. Keep in mind: You can't avoid taxes by reinvesting your dividends. Dividends are taxable income whether they're received into your account or invested back into the company. Most dividend-paying companies are large-cap, well-established, and well-endowed businesses. These mature corporations don't need to reinvest earnings back into the business, the way small- and mid-cap companies or startups often do. Industry sectors that are rich in dividend-paying companies — and whose companies pay rich dividends — include: Although all dividends come from the same source — the company earnings — the nature of their payouts depends on the class of shares you hold. Occasionally, companies issue a special dividend — an extra payout to common stockholders. Special dividends usually are issued by firms who have either stockpiled a lot of cash over the years or experienced a windfall — from spinning off a subsidiary, for example. While often much larger than the regular variety, this "extra" dividend is a one-time thing. Most companies pay dividends in cash. When a company declares a dividend, shareholders who own stock as of a date specified in the announcement are entitled to the payment. The payments are made on a per-share basis. For example, if a company you owned 1,000 shares declared a dividend of 50 cents per share, you would be paid $500. If you are looking for income from your stock on a regular basis, cash dividends are among the best sources. Dividends are normally declared quarterly, and investors will receive quarterly cash payments. This can be seen as a sort of reward for investing in the company. However, not every company issues cash dividends. A stock dividend is when the company pays the shareholders with additional shares of stock. This kind of dividend is uncommon. If you don't need income or immediate cash, you can defer the income by selling the stock later. The best scenario is that the stock appreciates in value over this time. The risk is that the stock declines in value. Stock dividends are typically issued by smaller companies looking to increase liquidity and the number of shares in the market, says George Metrou, an equity portfolio manager at Morningstar Investment Management. "However, a company paying a stock dividend could be a sign of financial distress and it may signal they are trying to conserve cash," Metrou says. "This is especially true if they were paying a cash dividend and switched to a stock dividend. Beyond the basic dollar amount, dividends are evaluated in a few different ways. Dividend yield In terms of valuing a dividend, investors look at a stock's dividend yield — the amount of the annual dividend divided by the stock price on a particular date. Measuring the dividend yield levels the playing field when comparing stocks and their dividend payouts. For example, a stock with a $10 share price and a quarterly payout of 10 cents per share yields a 4% dividend. At the same time, a $100 stock that pays $1 per share, also on a quarterly basis, likewise yields a 4% dividend. Yield and stock prices relate inversely to each other. As dividends increase, stock prices decrease. So dividend yields go up in one of two ways: Dividend payout ratio Beyond looking at a stock's dividend yield, however, savvy dividend investors look even more closely at the dividend payout ratio to gain a quick assessment of their reliability. The payout ratio measures the portion of a company's net income that goes toward shareholder dividend payments. The higher the payout proportion, the lower the margin of safety. As a rule of thumb, investors look for payout ratios that fall below 80% of a company's net income. Dividend-paying companies also incentivize investors seeking prudent financial vehicles. While stock investing often triggers capital gains implications, IRS accounting rules around dividend payments create a somewhat kinder, gentler tax hit. Rather than paying a higher capital gain rate, ordinary income rates apply to dividend payouts. Dividends for a company are typically paid out every quarter, as long as you were holding the stock before the ex-dividend date, which is the cutoff date at which you need to hold a stock in order to receive the dividend. There can also be a minimum stock-holding requirement to earn a dividend. A dividend reinvestment plan (DRIP) allows you to invest any dividends you received from a security back into it, instead of receiving it as a cash deposit in your brokerage account. They can be helpful for long-term investors looking to double down on an investment with lower costs than normal. But even though the dividends are reinvested, they're still subject to capital gains taxes. DRIPs operate using an investing strategy called dollar-cost averaging, in which you invest a certain amount of money at regular intervals, which averages out the costs of investing while minimizing the risk and volatility you're exposed to. There are some key dates surrounding dividends — especially pertaining to when a stockholder qualifies for them. Top Offers From Our Partners BrioDirect High-Yield Savings Account Earn 5.35% APY when you open a new account with qualifying deposit. No monthly maintenance fees. You must deposit at least $5,000 to open your account and maintain $25 to earn the disclosed APY.What is a dividend?
How are dividends taxed?
How much tax do you pay on dividends?
How can you avoid paying taxes on dividends?
Stocks that pay dividends
Kinds of dividends
Cash dividends vs. stock dividends: At a glance
How are dividends evaluated?
What is a dividend reinvestment plan (DRIP)?
Important dividend dates to know
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