How Online Investment Dividends Are Taxed
Thanks to the Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends caught a big-time tax that were later extended by the American Taxpayers Relief Act of 2012. Dividends that meet certain criteria are considered qualified and are taxed at the same favorable rate as long-term capital gains, as discussed in the preceding section.
That was a huge break, because prior to that, dividends were taxed at the typically much higher short-term capital gains rate. But, to get the lower tax treatment, dividends must be:
Qualified: Dividends from most companies that trade on U.S. exchanges are qualified. There are important exceptions, though, including some dividends paid by real-estate investment trusts, or REITs, which typically own commercial real estate such as apartment buildings and strip malls. Also keep in mind that dividends paid by money market accounts and many bond funds don’t qualify either because they’re considered interest.
The Fairmark.com website has a set of tools that can help you decide what kinds of dividends you have and how they’re taxed.
Paid to a shareholder who holds the stock for the right amount of time: To qualify for the lower rates, you must own the stock for a long enough time. The IRS says you must own the stock for more than 60 days during the 121-day period starting 60 days before the stock’s ex-dividend date. The ex-dividend date is the day a new investor who bought the stock is no longer entitled to dividends declared by the company. For more information on this, Fidelity.com has a section that explains qualified dividends. The Securities and Exchange Commission explains the ex-dividend date.
The big tax break that dividends have enjoyed since 2002 may not last forever. Some high earners have already lost it. A new 20 percent dividend tax rate was created for those of you lucky enough to be in the top tax bracket of 39.6 percent. The Patient Protection and Affordable Care Act also ushered in a new 3.8 percent Net Investment Income Tax that applies to dividends and capital gains for married taxpayers earning more than $250,000 and single taxpayers hauling more than $200,000. It’s just a reminder that taxes aren’t always low forever.
Investors who buy investments and hold them for a long time get a huge tax advantage over short-term traders. By holding stocks, you can put off the time when you have to pay tax on your gains. That allows your entire, untaxed ball of cash to snowball tax deferred. But even long-term investors have to pay taxes on dividends each year.