Dividends and Taxes: An Intro Guide

For most taxpayers, wages and salaries make up the majority of annual income. If you earn additional income from dividends, capital gains, or rental properties, your taxes immediately become more complex.

If you receive dividend payments, you need to have a basic understanding of dividend tax and how it works. The good news is that it’s simpler than you might think.

In this guide, we’ll do a deep dive into dividends and taxes to help you understand how dividends are taxed and how much you can expect to pay. If you’re a little confused about the tax on dividends, here’s everything you need to know.

What are ordinary dividends and qualified dividends?

A dividend is a payment distributed by a company to its shareholders. Each shareholder receives dividend payments regularly based on recent earnings of the company.

Generally speaking, dividends are paid to shareholders quarterly. The board of directors will convene to determine the dividend amount that should be paid to each common shareholder, and payments will be paid directly to shareholders’ accounts.

Common stockholder dividends may vary from period to period based on company performance. Holders of preferred stock will have a fixed dividend, rather than a variable.

Dividends aren’t always paid in the form of cash. In some cases, a company may choose to pay dividends in the form of additional shares. Only qualified shareholders who own stock before the ex-dividend date are eligible to receive dividends. 

The ex-dividend date refers to the date that dividends are allocated. Shareholders who sell their shares on or before this date will receive the dividend, even if they do not sell the stock before the dividend is actually paid.

In addition to the two types of shares, there are also two types of dividends: Qualified dividends and ordinary dividends. The type of dividends you receive will determine how your dividend payments are taxed. Ordinary dividends are taxed as ordinary income.

Qualified dividends are taxed at lower rates to encourage companies to share a portion of profits with shareholders. As an investor, qualified dividends encourage you to hold on to your stocks for an extended period of time.

While dividends can make stocks more attractive to investors, some companies don’t pay dividends. It’s important to understand the company you’re investing in and how you’re going to see a return on your investment.

How are dividends taxed?

If you receive ordinary dividend payments, the dividend tax rate will be the same as your ordinary income tax rate.

Qualified dividends are taxed as capital gains, which means you pay the capital gains tax rate instead of the income tax rate. This means most investors will pay less taxes on qualified dividends than they would on ordinary dividends.

Most dividends you receive from US corporations meet the qualified dividend requirements set by the IRS. However, certain foreign entities and real estate investment trusts (REITs) may not meet those requirements.

You have to hold onto your stocks for a certain time period to receive qualified dividend payments from qualified corporations. This period is generally at least 61 days within a 121-day period that starts 60 days after the ex-dividend date. Don’t worry if that part sounds complicated. The company paying your dividend is responsible for identifying which dividends are qualified and which are ordinary and reflecting this on the 1099-DIV form.

Holding onto your investments is a key part of maximizing investment gains. Whether you’re avoiding the short-term capital gains tax from short holding periods or ensuring your dividends will be treated as qualified, holding your investments can offer significant benefits.

How much is dividend income taxed?

Qualified dividends are taxed using the capital gains tax rate. The capital gains tax rate varies based on your taxable income and filing status, with tax rates ranging from 0% to 20%.

Your capital gains tax rate is 0% if your taxable income is equal to or below:

• $47,025 for single and married filing separately
• $94,050 for married filing jointly and qualifying surviving spouse
• $63,000 for head of household

Your capital gains tax rate will increase to 15% if your taxable income is:

• More than $47,025 but less than $518,900 for single filers
• More than $47,025 but less than $291,850 for married filing separately
• More than $94,050 but less than $583,750 for married filing jointly and qualifying surviving spouse
• More than $63,000 but less than $551,350 for head of household

If your taxable income exceeds the upper end of the 15% threshold amounts, the income that exceeds that threshold number will be taxed at the 20% rate. This is the highest rate for qualified dividends.

Most taxpayers are taxed at either the 0% or 15% rate. The maximum 20% rate only applies to high-income investors, so you can expect to pay a reasonable rate on your capital gains.

When it comes to qualified dividends, there’s one exception where your income may be taxed at a higher rate. The taxable part of a gain from selling section 1202 qualified small business stock can be taxed at up to 28%.  This is not something that applies to very many taxpayers.

How to pay taxes on dividends

Before you can file and pay your taxes, you’ll need Form 1099-DIV. This form is sent to you to report the type and amount of dividend payments you received.

Even if you don’t receive a 1099-DIV reporting the dividends you received, you’re still responsible for paying taxes. Any dividends you receive should be reported on your tax return regardless of whether you received a 1099-DIV.

Once you have your 1099-DIV, you can start filling out your tax return using Form 1040. Your ordinary dividends can be found in box 1a of your 1099-DIV. Qualified dividend amounts are found in box 1b of your 1099-DIV. These dividends should be entered on line 3a of Form 1040.

TurboTax makes it easy to enter both your ordinary dividends and qualified dividends. Just follow the step-by-step instructions when entering your 1099-DIV form(s), and TurboTax will ensure the amounts are reported on the correct forms.

If you had more than $1,500 in ordinary dividends or received ordinary dividends that belonged to someone else, you also need to file Schedule B (Form 1040). 

When you have finished entering all of your tax forms and information into TurboTax, you will then be able to complete your state tax return, if applicable. 

TurboTax will then review the information to ensure everything is answered as needed. You will then be able to electronically file your tax return with the IRS and state taxing agencies if applicable.

TurboTax Live also has the option of assistance from tax experts who can answer questions or even full service experts who can prepare your tax returns from start to finish.

How to avoid taxes on dividends

The tax on dividends can add up quickly when you’re receiving large distributions, but there are strategies you can use to reduce your taxable income and save on your taxes at the end of the year.

Capital gains tax rates are based on your income and filing status. If you reach the threshold for the 15% rate, you could save significantly by reducing your taxable income enough so that you’re taxed at the 0% rate.

You can reduce your taxable income by contributing to a retirement account or health savings account (HSA). If you manage to reduce your income enough that dividends are within the 0% threshold, you don’t have to worry about paying taxes on qualified dividend income.

If you own stocks in a Roth IRA account, any dividends you receive aren’t taxed. As long as you withdraw dividends after the age of 59-½ and wait until at least five years after the account was opened, you don’t have to worry about taxes.

If you have a traditional IRA, you also don’t pay taxes on dividends. Instead, you pay ordinary income tax on withdrawals. Therefore, some taxpayers will put their dividend-paying investments in retirement accounts and hold growth stocks or funds that don’t pay dividends in their nonqualified accounts.

If you want to maximize your tax savings, planning ahead is key. A tax expert or tax attorney can help you find ways to minimize your dividend taxes and save money. The earlier you prepare for tax season and find ways to reduce your taxable income, the better the results will be.