Dividends that you earn on your investments are typically taxable, but the rate at which you’re taxed depends on capital gain rates and on what type of dividend you earn. For instance, some dividends are considered qualified, and others are considered non-qualified. Each is taxed at a different rate.
What Are Dividend Taxes?
Dividend taxes are taxes that are imposed on a shareholder after being paid dividends by a corporation. In other words, if you own shares in a corporation and are paid dividends from it, you will be taxed on the dividends that you earn.
There are some exceptions to this rule, such as when you deposit your dividends directly into a retirement account such as a Traditional IRA or a 401(k). If your income falls into the three lowest federal tax brackets, you will not pay taxes on earned dividends.You will not owe taxes on dividends if they are issued to you and are classified as a return on your capital. For instance, if you bought a stock for $100 and the dividend issued to you by the company was $4 and that was due to a return on your $100, you will not owe taxes. But in the future when you sell shares, the $4 will be subject to capital gains tax.
Types of Dividend Taxes
The dividend tax rates you pay depend on the type of dividends you receive. The corporation will issue qualified dividends or nonqualified dividends, and you must understand which type you receive to properly pay your taxes.
1. Qualified Dividends
Qualified dividends are eligible for the lower long-term capital gains tax rate as long as the dividends meet certain requirements outlined by the Internal Revenue Service (IRS). Dividends must meet the following requirements to be issued as qualified dividends.
It must be paid to the shareholder by a qualifying foreign company such as one that is operating in a country that is eligible for benefits under a U.S. tax treaty, a foreign company in U.S. possession or a foreign company’s stock that is traded on a major U.S. stock market; or it must be a U.S. company. The dividends cannot be listed with the IRS.
The shareholder must have met the required holding period. That means the stock must have been held for longer than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is typically set at one day before the record date, which is the date the company looks at its shareholders to determine which ones will receive dividends.
If the dividends come from preferred stock, the holding period is different. In this case, the stock must have been held by the shareholder for more than 90 days during the 181-day period that begins 90 days before the ex-dividend date.
Qualified dividends receive tax treatment depending on your annual income. Here are the rates for 2023:
- Single taxpayers with income up to $44,625 pay no taxes on their dividends.
- Married taxpayers filing jointly with income up to $89,250 pay no taxes on their dividends.
- Head of households with income up to $59,750 pay no taxes on their dividends.
- Single taxpayers with income between $44,635 to $492,300 pay a 15% tax on their dividends.
- Married taxpayers filing jointly with income between $88,250 and $553,850 pay a 15% tax on their dividends.
- House of household taxpayers with income between $59,750 and $523,050 pay a 15% tax on their dividends.
- Single taxpayers with an income of $492,300 or more pay a 20% tax on their dividend income.
- Married taxpayers filing jointly with an income of $553,850 or more pay a 20% tax on their dividends.
- House of household taxpayers with an income of $523,050 or more pay a 20% tax on their dividend income.
If you were issued qualified dividends, you will receive an IRS Form 1099-DIV, and you should list the qualified dividend income in box 1b.
2. Nonqualified Dividends
Nonqualified dividends are dividends that are automatically excluded from being considered qualified and are taxed at the same rate as your ordinary income. Nonqualified dividends include dividends from real estate investment trusts (REITs), dividends from tax-exempt companies, those paid by master limited partnerships (MLPs) and those paid from employee stock options.
Dividends you receive from deposits on money market accounts, credit unions or banks are considered nonqualified.
For 2023, the tax treatment ranges from 10% to 37%, and whatever tax rate you fall in is the same dividend tax rate at which yours will be taxed. You will receive an IRS Form 1099-DIV, and you should list the nonqualified dividend income in box 1a.
For qualified and nonqualified dividends, you may owe an additional tax called the Net Investment Income Tax if you meet certain income levels. If you are single and have a modified adjusted gross income of more than $200,000 in 2023, you may owe tax. If you are married and filing jointly with an income of more than $250,000, you may owe the tax. The Net Investment Income Tax applies to qualified and nonqualified dividends as well as realized gains. It is at 3.8% in 2023.
Benefits of Hiring an Accountant for Dividend Taxes
Anytime you are dealing with income and taxes, it makes sense to hire an accountant or tax preparer to help find all legal deductions and ensure that your taxes are properly paid. Here are some of the benefits of hiring an accountant when part of your income is dividend taxes.
- Filing status: When claiming dividend payments, your tax filing status can affect how much you pay in taxes. For instance, an accountant can help you determine if you should file married filing jointly or married filing separately.
- Classification: While the rules of tax dividends and whether they are qualified or nonqualified seem simple, an accountant can ensure that yours are classified correctly. For some, an incorrect classification can mean the difference between paying taxes and not paying any.
- Retirement accounts: Many people choose to put their dividend income in retirement savings accounts to defer or avoid paying taxes, and an accountant can give you practical advice about which type of account would best suit your needs.
- Tax rates: The lower your tax rate, the fewer taxes you will pay on your dividends. And an accountant can ensure that you take all the legal deductions you can. That could mean that you will qualify for a lower dividend tax rate, which means you will pay fewer taxes on your dividends.
How to Offset Dividend Taxes
Earning dividends is a great way to earn passive income, but if you can offset the taxes, you will benefit even more. Here are some ways you can legally offset your dividend taxes to keep more of what you earn.
- Earn qualified dividends: While all dividends put money in your pocket, you will pay fewer taxes on qualified dividends. Before investing in shares, review the requirements above for qualified dividends and make sure you’re investing in those.
- Pay attention to deductions: Whether you earn qualified or nonqualified dividends, your tax rate depends on what your income is. But you can reduce your income by taking all the legal deductions you can. You may need to work with an accountant, but you should that you do all you can to qualify for the lowest tax bracket that you qualify for by taking all legal deductions. For instance, think about maxing out your 401(k).
- Defer your taxes: How you are taxed on dividends depends on where the money is paid to. For instance, if you have your dividends paid to a retirement account, you can defer or eliminate taxes.
- Think rentals. Another way to offset your dividend taxes is to purchase a rental property. Between taking depreciation on the property and the expenses of running it, you offset your other income.
Maximizing Dividend Returns
An accountant can be invaluable when it comes to minimizing your dividend taxes. They can give you advice on which type of account would suit your needs best and help you take advantage of legal deductions to reduce your income and qualify for the lowest tax bracket possible. Additionally, consider investing in qualified dividends or deferring taxes by putting your dividends into retirement accounts. Think about investing in a rental property to further offset your dividend taxes. Keeping this advice in mind can help you keep more of the money you earn from dividends.
Dividend Taxes vs. Stock Taxes
No matter what type of investment income you make, you are likely to pay taxes on them. But the amount of taxes you pay will depend on the investment. Unlike dividend earnings that are usually issued quarterly, when you sell a stock, you no longer own that stock and will not enjoy future income from it. If you hold the stock for less than a year before you sell it, you will pay a short-term capital gains tax on the profits, which is at the same rate as your federal income tax bracket. If you sell a stock that you have held onto for more than a year, you will be taxed on the profits depending on your income bracket. The rates are 0%, 15% and 20%.
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Frequently Asked Questions
How do you pay taxes on dividends?
The way you pay taxes on dividends is simple. If you earned $10 or more from any entity, you will be issued an IRS Form-1099 DIV. If the dividends that you earned were nonqualified, such as those from a money market account, REIT, tax-exempt company, an MLP or employee stock options, you report your nonqualified dividends on line 1a of the form. If you earned qualified dividends, you report them on line 1b of the form. If any of the above is confusing to you, then it might be wise to consult a tax professional for further guidance.
What is the tax rate on dividends?
The dividend tax rate you will pay depends on which type of dividend you earn and your annual income. If you were paid qualified dividends, you will pay between 0% and 15%. If you earned nonqualified dividends, you will have the same tax rate that you pay for your ordinary income. Those tax brackets range from 10% to 37%.
What if I overpay my dividend taxes?
If you overpay your dividend taxes, you can file for a refund with the IRS. You can do this by filing an amended tax return or by contacting the IRS directly. It is important to keep accurate records of your dividend income and taxes paid to avoid overpaying in the future.