Taxes on Dividends: Answers to 4 Key Question

Buy a stock that pays a dividend, and a company pays you passive income every quarter in the U.S. and semi-annually in most other countries.

However, in most cases, everyone must pay taxes on dividends. In the U.S. and most other countries, for that matter, dividends are considered income, and hence they are taxed.

In the U.S., though, dividends can have favorable tax treatment for many small investors, making them tax efficient in regular brokerage accounts. It is also possible for dividend-paying stocks to be held in tax-advantaged accounts delaying or reducing federal income tax on dividends.

One of the most important is that dividends are a return of cash to an investor. A company can return some money to stock owners by buying back shares or paying a dividend. However, when a company pays a dividend, the investor decides what to do with that money.

Why do Investors Love Dividends So Much?

What is the Tax Rate on Dividends?

The difference in the tax rate can be dramatic depending on your income. Families in the highest income tax bracket pay a 37% tax rate on regular income and only a 20% tax rate on dividends. For families closer to the median U.S. family income of about $67,521 in 2020, the tax rate on regular income is 12%, but it is 0% on dividends.

In general, the answer is no, but there are exceptions. Dividends are a type of income, so they are taxable. Reinvesting dividends in the same stock or mutual fund or ETF, for that matter, does not avoid taxes. You must still pay taxes on the dividends.

Can You Avoid Taxes on Dividends?

What About Tax-Advantaged Accounts?

More people own a retirement account than a taxable brokerage account. Owning a retirement account is an advantage and a legitimate way to defer or avoid taxes on dividends. It is also a good way to leverage the power of compounding by reinvesting the dividends tax-free.

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