Are dividends taxed higher than capital gains?
Dividends can be ordinary or qualified, and all ordinary dividends are taxable as income. Qualified dividends receive the lower capital gains rate. So, qualified dividends are capital gains for tax purposes. As a practical matter, most stock dividends in the U.S. qualify to be taxed as capital gains.
Dividend payments are usually more stable than capital gains. Stock dividends do not increase the value of a shareholder's position. Stock dividends and stock splits both increase the number of shares but add nothing to the value of the company.
The dividend is defined as the profit percentage given by an organisation to its investor. Capital gain is defined as the profit made by an investor after selling their stocks in an organisation. The dividend is paid on a periodical basis subject to the company policies.
Dividend Gross-up Creates the “Taxable Dividends” Amount
The “grossed up” amount approximates the equivalent before-tax amount in the corporation. This is why the “taxable” amount of dividends paid on your T5 slip is higher than the actual amount of dividends paid, and why it's important that it's included on the slip.
When it comes to the future, dividends are more stable because companies tend to pay them out regularly. Capital gains, on the other hand, can be more volatile because the prices of assets can go up or down.
One of the key benefits of dividend reinvestment is that your investment can grow faster than if you pocket your dividends and rely solely on capital gains to generate wealth. It's also inexpensive, easy, and flexible. Still, dividend reinvestment isn't automatically the right choice for every investor.
Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates.
Capital gains do not include ordinary income, such as interest or dividend income. Although qualified dividends are taxed at long-term capital gains rates under current tax law, you cannot use capital losses to directly offset qualified dividends.
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%.
You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.
Do dividends count as income?
All dividends paid to shareholders must be included on their gross income, but qualified dividends will get more favorable tax treatment. A qualified dividend is taxed at the capital gains tax rate, while ordinary dividends are taxed at standard federal income tax rates.
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.
Dividends can be a great way to earn an income stream from your investments, but, like all income, they are also taxed. Depending on the type of dividend, qualified or nonqualified, you will be taxed at either your ordinary income tax bracket or the capital gains tax bracket, which is usually a lower tax rate.
| Dividend Tax Rate, 2022 | ||
|---|---|---|
| Filing Status | 0% Tax Rate | 20% Tax Rate |
| Single | $0 to $41,675 | $459,751 or more |
| Married Filing Jointly | $0 to $83,350 | $517,201 or more |
| Married Filing Separately | $0 to $41,675 | $258,601 or more |
This means that dividend income will be taxed at a lower rate than the same amount of interest income. Investors in the highest tax bracket pay tax of 39% on dividends, compared to about 53% on interest income.
Double taxation occurs when taxes are levied twice on a single source of income. Often, this occurs when dividends are taxed. Like individuals, corporations pay taxes on annual earnings. If these corporations later pay out dividends to shareholders, those shareholders may have to pay income tax on them.
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.
The net capital losses can be applied to ordinary income as well as dividend income. Otherwise, however, capital losses can't be used to shelter dividend income from taxes.
Cons. You'll Limit Your Asset Diversification: Reinvesting your dividends in a company you already own shares of can result in an unbalanced portfolio. You Could Still Owe Taxes: It's important to note that dividends are taxed whether you take a cash payout or reinvest them.
Reinvesting dividends will increase your position in the company paying them. If that company already represents, say, 5% or more of your portfolio, it may be wise to avoid getting too concentrated and not reinvest your dividends.
Can you avoid capital gains tax on stocks by reinvesting?
With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.
Key Takeaways
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%.
So, again, long-term capital gains are taxed at different rates and separately from your ordinary income. Your ordinary income is taxed first, at its higher relative tax rates, and long-term capital gains and dividends are taxed second, at their lower rates.
Investors pay taxes on the dividend the year it is announced, not the year they are paid the dividend.
- Invest for the Long Term.
- Take Advantage of Tax-Deferred Retirement Plans.
- Use Capital Losses to Offset Gains.
- Watch Your Holding Periods.
- Pick Your Cost Basis.
