For stock investors, dividend-paying equities offer an extra stream of income that you can enjoy for years. But what can be even better is how that dividend income will (or won't) impact your tax bill.
When it comes to the IRS, all income is not created equal. So if the idea of earning more money and getting taxed less on it -- or even not taxed at all -- appeals to you, here's a rundown of the rules around dividends that can make that possible.
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Unlocking the benefits of dividends
Typically, investors make most of their money in the stock market by selling shares at a profit. But by purchasing shares of dividend-paying stocks, you can get rewarded regularly for holding onto those shares.
Companies pay their investors dividends based on the number of shares they own. If, for example, a company distributes an annual dividend of $2 per share and you own 1,000 shares, you'll qualify for $2,000 in dividends as long as you've met the holding period requirements.
Typically, dividends are paid quarterly, though a small minority of companies distribute them on other schedules. Each time the board of directors declares a dividend, you will receive deposits in your account. And if a company increases its dividend payout -- which some have a habit of doing at least once a year -- you'll get those "pay raises" without having to do anything extra at all.
Taking advantage of the 0% tax bracket
As every adult American rapidly learns, income from ordinary employment is taxed in brackets. The more you earn, the higher the marginal rate will be on the share of your income that falls into your top bracket.
The same is true for certain types of income earned from the stock market, but the brackets involved are different: Most money made via investing will fall within the brackets of 0%, 15%, or 20%. While most people's investment-related income will be taxed at 15% due to their non-investment income, it isn't impossible for yours to fall into the 0% tax bracket -- especially if the majority of your income is derived from dividends.
Here's the key: You can only get tax-free treatment on as much dividend income as leaves you with total taxable income -- including those dividends -- of less than $40,401 as a single filer or less than $80,801 as a married couple filing jointly. Also, as you'll see below, your dividends must be considered qualified. But first, take a look at the 2021 qualified dividends tax table to see the full list of income levels for various tax rates.
2021 qualified dividends
For Single Filers With Taxable Income of... | For Married Joint Filers With Taxable Income of... | For Married Couples Filing Separately With Taxable Income of...
| For Heads of Households With Taxable Income of... | ...This Is the 2021 Qualified Dividends Tax Rate |
|---|
$0 to $40,400 | $0 to $80,800 | $0 to $40,400 | $0 to $54,100 | 0% |
$40,401 to $445,850 | $80,801 to $501,600 | $40,401 to $250,800 | $54,101 to $473,750 | 15% |
Over $445,850 | Over $501,600 | Over $250,800 | Over $473,750 | 20% |
DATA SOURCE: IRS.
Earning tax-free qualified dividends
Not all dividends qualify for this favorable treatment. Some types of companies, such as REITs and MLPs, force shareholders to pay taxes on their distributions at your ordinary marginal rates, which could be as high as 37%.
However, you could also fill your portfolio up with stocks that pay qualified dividends, granting you access to the 0%, 15%, and 20% tax brackets. For you to take advantage of those rates, both you and the company have to follow the rules.
First, the dividend must be paid by a U.S. corporation or qualifying foreign entity. Next, the dividend must actually qualify as a dividend as defined by the IRS, and must not be included on the list of exemptions for qualified dividend tax treatment. For instance, you can't receive an annual distribution from a credit union or employee stock option and expect to receive qualified dividend treatment. Third, you must have held the stock paying the dividend for more than 60 days during the 121-day holding period that begins 60 days before the ex-dividend date.
Make the most of every dividend
If you haven't started your dividend investing journey yet, the possibilities of tax-free or low-tax income may just be the extra inducement you need to get you on your way. If you're already on a mission to build a robust dividend portfolio, you can use the qualified dividends and long-term capital gains rates to maximize your opportunities to earn more and pay less in taxes.
FAQs
Under the Treaty, there is a special exemption from U.S. withholding tax on interest and dividend income that you earn from U.S. investments through a trust set up exclusively for the purpose of providing retirement income. These trusts include RRSPs, RRIFs, LIRAs, LIFs, LRIFs and Prescribed RRIFs.
How much dividend income is tax-free? ›
Your “qualified” dividends may be taxed at 0% if your taxable income falls below $44,625 (if single or Married Filing Separately), $59,750 (if Head of Household), or $89,250 (if (Married Filing Jointly or qualifying widow/widower) (tax year 2023). Above those thresholds, the qualified dividend tax rate is 15%.
How do I claim dividend income exemption? ›
If your total dividend income is less than Rs. 5,000 in a financial year, then TDS will not apply to your interest income received. 2. You can submit Form 15G/15H to the company or mutual fund declaring that your total income for the financial year is below the taxable limit.
How do I avoid paying taxes on reinvested dividends? ›
Reinvested dividends may be treated in different ways, however. Qualified dividends get taxed as capital gains, while non-qualified dividends get taxed as ordinary income. You can avoid paying taxes on reinvested dividends in the year you earn them by holding dividend stocks in a tax-deferred retirement plan.
Is a stock dividend generally not taxable for federal income tax purposes? ›
If shares are held in a retirement account, stock dividends and stock splits are not taxed as they are earned. 1 Generally, in a nonretirement brokerage account, any income is taxable in the year it is received.
Do I have to pay taxes on my dividend stocks? ›
Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%. IRS form 1099-DIV helps taxpayers to accurately report dividend income.
Do dividends count as income if reinvested? ›
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.
Are reinvested dividends taxed twice? ›
Dividends are taxable regardless of whether you take them in cash or reinvest them in the mutual fund that pays them out. You incur the tax liability in the year in which the dividends are reinvested.
Do dividends count as income for Social Security? ›
Pension payments, annuities, and the interest or dividends from your savings and investments are not earnings for Social Security purposes. You may need to pay income tax, but you do not pay Social Security taxes.
How do you report dividend income on tax return? ›
Enter the ordinary dividends from box 1a on Form 1099-DIV, Dividends and Distributions on line 3b of Form 1040, U.S. Individual Income Tax Return, Form 1040-SR, U.S. Tax Return for Seniors or Form 1040-NR, U.S. Nonresident Alien Income Tax Return.
Also include on line 2a of your Form 1040 or 1040-SR any exempt-interest dividends from a mutual fund or other regulated investment company. This amount should be shown in box 12 of Form 1099-DIV. If an amount is shown in box 9 of Form 1099-INT, you must generally report it on line 2g of Form 6251.
Do I have to claim dividend income? ›
If you receive over $1,500 of taxable ordinary dividends, you must report these dividends on Schedule B (Form 1040), Interest and Ordinary Dividends. If you receive dividends in significant amounts, you may be subject to the Net Investment Income Tax (NIIT) and may have to pay estimated tax to avoid a penalty.
Why you should not reinvest dividends? ›
What is the downside to reinvesting dividends? Dividend reinvestment has some drawbacks. One downside is that investors have no control over the price at which they buy shares. If the stock gains significant value, they'd still buy shares at what could be a high price.
Is it better to reinvest dividends or take cash? ›
Your Money Could Lose Value Due To Inflation: Keeping your cash liquid will result in depreciation over time. Keeping the dividends reinvested instead allows your money to grow with the market over time.
What can offset dividend income? ›
If your losses are greater than your gains
Up to $3,000 in net losses can be used to offset your ordinary income (including income from dividends or interest). Note that you can also "carry forward" losses to future tax years.
Can I claim back US withholding tax on dividends? ›
If you reside in a country that has an income tax treaty with the country that taxed the dividend, and said treaty provides a lower tax rate when compared to the tax rate imposed on the dividend you received, you should be eligible for a refund of the excess tax withheld.
Who is responsible for withholding tax on dividends? ›
While the U.S. government taxes dividends paid by American companies, it doesn't impose tax withholdings for U.S. residents. In other words, each U.S. investor receives the full dividend amount and is responsible for reporting their annual dividends to the IRS each year and paying taxes accordingly.
Do I need to pay tax on US dividends? ›
How are US stocks' dividends taxed? Dividends over US Stocks Investments are taxed at source at a flat rate of 25%. The company deducts 25% of the dividend being allotted and distributes the remaining dividend to the users.
How much tax do I pay on US dividends? ›
Qualified dividends must meet special requirements issued by the IRS. The maximum tax rate for qualified dividends is 20%, with a few exceptions for real estate, art, or small business stock. Ordinary dividends are taxed at income tax rates, which as of the 2023 tax year, maxes out at 37%.
