What are the Tax Implications for Dividend Income?

What are Dividends

When companies and some mutual funds earn profits, they share them with shareholders through the payment of dividends. They are typically paid quarterly as cash, though they can also take to form of stock, stock options, rights, or property. They can be adjusted, and often are, based on the profitability of the company during the year, and as approved by the Board of Directors.

Qualified Dividends

A dividend is considered qualified by the IRS if you’ve held the stock or fund for a specified period of time. According to the IRS: a dividend is qualified if you have held the underlying stock for more than 60 days during the 121-day period that begins 60 days before the “ex-dividend date.” Ex-dividend dates determine if a shareholder has held to underlying stock long enough to receive a dividend payment.

Non-qualified Dividends

Also called “ordinary” dividends, these cover a wide range of company stock and fund dividends, including some REITs, Real Estate Investment Trusts. The main difference between non-qualified and qualified dividends is the tax rate you pay.

Tax Rates on Dividends

All dividends are taxed as income, but with different rates based on qualification. Qualified dividends are subject to capital gains taxes, while ordinary dividends are taxed at regular personal income tax rates. There are some funds and veterans-related policies that pay dividends exempt from federal taxes, but for the most part, you’ll pay personal income tax or capital gains taxes.

Qualified dividends are taxed at capital gains rates, while non-qualified are taxed at normal income rates. Following is a chart of those rates for 2020.

Income Tax Bracket

$0 – $9,875
$9,876 – $40,000
$40,001 – $40,125
$40,126 – $85,525
$85,526 – $163,300
$163,301 – $207,350
$207,351 – $441,450
$441,451 – $518,400
$518,401+

Income Tax Rate

10%
12%
12%
22%
24%
32%
35%
35%
37%

Capital Gains Rate

0%
0%
15%
15%
15%
15%
15%
20%
20%

You can see that the higher income brackets can save a significant amount in taxes by investing in stocks or funds and holding long enough to make them qualified.

Advantageous Investment for Dividends

Investing in dividend-paying stocks and funds in retirement accounts is a favorite of retirees. They get a quantifiable return, and growth from compounding dividends isn’t taxed in a retirement account, such as an IRA or 401(k).

How Dividends are Reported on Tax Returns

You’ll receive a Form 1099-DIV from your dividend-paying investments and financial accounts if you received dividends during the tax year. If you have more than $1,500 in total dividends during the year, you’ll report them on Schedule B of your return.

You may also receive a Schedule K-1. This form is for those who receive dividends (or other income) from a trust, estate, partnership, LLC, or S corporation. You may also get a Schedule K-1 if you invest in an ETF, Exchange Traded Fund, or a fund that operates as a partnership.

Dividends aren’t right for every investor or every financial situation, but they are right for many at the right time. Consult a financial professional for discussions as to how dividends may fit into your financial planning.

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