For stock investors, dividend-paying equities offer an extra stream of income that you can enjoy for years. But what can be even better is how that dividend income will (or won’t) impact your tax bill.
When it comes to the IRS, all income is not created equal. So if the idea of earning more money and getting taxed less on it — or even not taxed at all — appeals to you, here’s a rundown of the rules around dividends that can make that possible.
Unlocking the benefits of dividends
Typically, investors make most of their money in the stock market by selling shares at a profit. But by purchasing shares of dividend-paying stocks, you can get rewarded regularly for holding onto those shares.
Companies pay their investors dividends based on the number of shares they own. If, for example, a company distributes an annual dividend of $2 per share and you own 1,000 shares, you’ll qualify for $2,000 in dividends as long as you’ve met the holding period requirements.
Typically, dividends are paid quarterly, though a small minority of companies distribute them on other schedules. Each time the board of directors declares a dividend, you will receive deposits in your account. And if a company increases its dividend payout — which some have a habit of doing at least once a year — you’ll get those “pay raises” without having to do anything extra at all.
Taking advantage of the 0% tax bracket
As every adult American rapidly learns, income from ordinary employment is taxed in brackets. The more you earn, the higher the marginal rate will be on the share of your income that falls into your top bracket.
The same is true for certain types of income earned from the stock market, but the brackets involved are different: Most money made via investing will fall within the brackets of 0%, 15%, or 20%. While most people’s investment-related income will be taxed at 15% due to their non-investment income, it isn’t impossible for yours to fall into the 0% tax bracket — especially if the majority of your income is derived from dividends.
Here’s the key: You can only get tax-free treatment on as much dividend income as leaves you with total taxable income — including those dividends — of less than $40,401 as a single filer or less than $80,801 as a married couple filing jointly. Also, as you’ll see below, your dividends must be considered qualified. But first, take a look at the 2021 qualified dividends tax table to see the full list of income levels for various tax rates.
2021 qualified dividends
|For Single Filers With Taxable Income of…||For Married Joint Filers With Taxable Income of…||For Married Couples Filing Separately With Taxable Income of…||For Heads of Households With Taxable Income of…||…This Is the 2021 Qualified Dividends Tax Rate|
|$0 to $40,400||$0 to $80,800||$0 to $40,400||$0 to $54,100||0%|
|$40,401 to $445,850||$80,801 to $501,600||$40,401 to $250,800||$54,101 to $473,750||15%|
|Over $445,850||Over $501,600||Over $250,800||Over $473,750||20%|
Earning tax-free qualified dividends
Not all dividends qualify for this favorable treatment. Some types of companies, such as REITs and MLPs, force shareholders to pay taxes on their distributions at your ordinary marginal rates, which could be as high as 37%.
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