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dividend tax

Are you losing money to dividend tax?

Benjamin Franklin said, “…in this world nothing can be said to be certain, except death and taxes.” We may have a lot to pay, but there are times when one can legally avoid paying dividend tax under the right circumstances.

Dividends are paid to shareholders when portions of profits from businesses are distributed. Stocks and mutual funds pay dividends. It’s important to note that there are special rates for dividend income. Dividends can be ordinary, but if these meet the criteria to be qualified dividends, then they are taxed at a favorable rate.

Ordinary dividend tax

Dividend tax on ordinary dividends are just like regular income. Check the tax bracket to see what federal income tax rate you fall under; your dividend tax rate will be the same as your income tax rate.

Keep in mind your taxable income is equal to all your wages and other income after either the standard tax deduction, which changes based on your filing status, or itemized deductions. Whichever deduction is greater is the one that is applied.

Read also: 10 tax deductions and credits you should know about

However, you can still invest in equities and receive tax-deferred or tax-free income from ordinary dividends. 

One of the best ways to do this is to contribute to a retirement account. If you invest in equities through your ROTH retirement account, the dividend income will not be taxable if you withdraw them according to law guidelines. If you invest in a traditional IRA, the dividend income will be tax deferred.

You must have earned income to contribute to a retirement account, but investing in equities within your retirement account is a sure way to receive favorable status on your dividends.

Qualified dividend tax

The IRS outlines a qualified dividend as one that has the following characteristics: “the dividend must have been paid by a U.S. company or a qualifying foreign company, the dividends are not listed with the IRS as those that do not qualify, [and] the required dividend holding period has been met.”

If your dividend meets the above criteria, it is taxed under the capital gains tax. Capital gains tax rates are lower than ordinary dividend tax rates, sometimes qualifying for tax rates as low as 0%.

Ask a professional if it’s possible to take advantage of these rates in order to avoid dividend tax, as situations vary widely depending on where your dividend is coming from and if you plan on investing or saving that income within a fiscal year.

What next?

For many people, the next step is simple: if your investments pay qualified dividends, you probably don’t have to do anything! Most folks don’t have to pay a lot in dividend tax!

The average dividend income is about two percent, which means that, even if your portfolio is worth $100,000, your dividend income will only amount to about $2,000. Since there are three tax brackets for each filing status, a large percent of the population will not be taxed on their qualified dividends, even outside of a retirement account!

If you are in a higher tax bracket and have more money in your portfolio, then the next step is to examine your taxable income. Consult your trusted professional to see if it would be wise to invest in equities within your retirement account in order to avoid dividend tax. Another option may be to invest in tax-free income funds that receive their income from municipal bonds.

Tax law can be very tricky! Before you take any action on your return to minimize your dividend tax liability, it is always extremely important to consult a Certified Public Accountant! For more information on taxes and investing, check out the rest of the Acadmey learning library. 

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