Like other earnings and realized gains on investments, dividend income is taxable. The tax rate on dividends, however, is dependent on a number of factors, including your taxable income, the type of dividend, and the kind of account that holds the investment. This means that the amount of the tax that you owe on dividends can vary.
Let's take a closer look at the various factors that can affect how much tax you owe on the dividends you earned in 2022 and any you earn in 2023.
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Are dividends taxed?
Are dividends taxed?
The short answer to this question is that yes, in most cases, the IRS taxes dividend income. A more complete answer is yes, but not always; it depends on a few circ*mstances. Let's look at some exceptions.
A common exception is dividends paid on stocks held in a retirement account such as a Roth IRA, traditional IRA, or 401(k). These dividends are not taxed since most income or realized capital gains earned by these types of accounts is tax-deferred or tax-free.
Taxable Income
Taxable income is the amount of income subject to taxation after deductions and exemptions.
Another exception is dividends earned by anyone whose taxable income falls into the three lowest U.S. federal income tax brackets. For single filers, if your 2022 taxable income was $41,675 or less, or $83,350 or less for married couples filing jointly, then you won't owe any income tax on dividends earned. The numbers increase to $44,625 and $89,250, respectively, for 2023.
There are also some types of events that pay a dividend-like income that is not taxable. The most common event is a return of capital. In this case, the company is sending you money much like a dividend, but it's classified as a return on some of the capital that you invested. While not taxable today, receiving this type of dividend could increase your future taxes since your capital gain on the stock is increased by the amount of the dividend that you received.
Here's a specific example: If you pay $20 for a single share and the company sends you a $0.50 dividend payment classified as a return of capital, then your cost basis decreases to $19.50. If you sell the share in the future for a profit, then that's an extra $0.50 that's subject to capital gains taxes.
How to determine the tax
How to determine owed tax on stock dividends
Whether you owe taxes on a dividend depends on three factors:
- Type of investment account: You may owe tax on dividends earned by stock held in a taxable brokerage account. You would not owe tax on dividends from stocks held in a retirement account, such as a Roth IRA or 401(k), or a college savings plan, such as a 529 plan or Coverdell ESA. There are exceptions to this tax immunity, though. Certain pass-through entities, such as master limited partnerships, can create tax obligations even for retirement accounts.
- Type of dividend: The tax rate, if any, depends in part on the type of dividend. A qualified dividend is eligible for a lower tax rate. An ordinary or nonqualified dividend gets taxed at the investor's ordinary income tax rate. Finally, a nontaxable distribution, such as a return of capital, isn't taxable.
- Your taxable income: Your tax bracket partly determines the tax rate applied to any dividends you earn, whether qualified or ordinary.
Here's a summary of when you won't pay tax on dividends:
- If your taxable earnings are in one of the three lowest federal income tax brackets and you receive qualified dividends.
- If the dividends are earned in a tax-deferred account such as one of those described above, even if your tax bracket is not one of the three lowest.
- If the dividend was a nontaxable dividend, such as a return of capital.
How much tax?
How much tax do you owe on dividends?
Now, let's examine how much tax is assessed on taxable dividends.
Dividends are taxed differently based on whether they are considered qualified or ordinary dividends under U.S. tax law. Qualified dividends get taxed at favorable rates, while nonqualified or ordinary dividends are taxed at your ordinary income tax rate. For a dividend to be considered qualified for tax purposes, it must meet two main criteria:
- The dividend is paid by a U.S. corporation domiciled in a U.S. state or territory or a foreign corporation listed on a major U.S. stock exchange. That might sound like it includes most stocks, but keep in mind that the payouts from certain types of investments aren't treated as qualified dividends. Real estate investment trusts (REITs) and certain pass-through entities, including master limited partnerships, pay out distributions that are typically taxed as ordinary income rather than at the preferential rates reserved for qualified dividends.
- You owned the stock that is paying the dividend for more than 60 days within a specific 121-day holding period. The 121-day period begins 60 days before the ex-dividend date of the stock, which is exactly 60 days before the next dividend is distributed. The mandatory holding period prevents traders from earning tax-advantaged income on stocks that they hold for only a few days.
The following tables break down the current tax rates assessed on qualified dividends, depending on your taxable income and filing status in 2023:
| 2023 Qualified Dividend Tax Rate | For Single Taxpayers | For Married Couples Filing Jointly | For Heads of Household |
|---|---|---|---|
| 0% | Up to $44,625 | Up to $89,250 | Up to $59,750 |
| 15% | $44,625-$492,300 | $89,250-$553,850 | $59,750-$523,050 |
| 20% | More than $492,300 | More than $553,850 | More than $523,050 |
The next table presents the tax rates assessed on ordinary or nonqualified dividends in 2023, depending on your taxable income and filing status:
| 2023 Ordinary Dividend Tax Rate | For Single Taxpayers | For Married Couples Filing Jointly | For Heads of Household |
|---|---|---|---|
| 10% | Up to$11,000 | Up to $22,000 | Up to $15,700 |
| 12% | $11,000 to $44,725 | $22,000 to $89,450 | $15,700 to $59,850 |
| 22% | $44,725 to $95,375 | $89,450 to $190,750 | $59,850 to $95,350 |
| 24% | $95,375 to $182,100 | $190,750 to $364,200 | $95,350 to $182,100 |
| 32% | $182,100-$231,250 | $364,200 to $462,500 | $182,100 to $231,250 |
| 35% | $231,250 to $578,125 | $462,500 to $693,750 | $231,250 to $578,100 |
| 37% | Over $578,125 | Over $693,750 | Over $578,100 |
To summarize, here's how dividends are taxed, provided that the underlying dividend stocks are held in a taxable account:
- Qualified dividends are taxed at 0%, 15%, or 20%, depending on your income level and tax filing status.
- Ordinary (nonqualified) dividends and taxable distributions are taxed at your marginal income tax rate, which is determined by your taxable earnings.
Net Investment Income Tax
High earners may owe the Net Investment Income Tax
In addition to the dividend taxes described above, dividend investors with modified adjusted gross incomes of more than $200,000 (for single taxpayers) or $250,000 (for married couples filing jointly) are also subject to the Net Investment Income Tax. The tax is assessed regardless of whether the dividends received are classified as qualified or ordinary.
Related investing topics
The Net Investment Income Tax is an additional 3.8% tax that applies to dividend income as well as to realized gains. It increases the effective total tax rate on dividends and other investment income.
Yet even with this surcharge, qualified dividends are taxed at significantly preferential rates vs. regular income. The tax break doesn't reduce the risk of investing in the underlying stock, but it does allow you to keep more of your hard-earned gains for yourself.
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Insights, advice, suggestions, feedback and comments from experts
Introduction
As an expert in taxation and investment, I can provide you with detailed information about how dividends are taxed. I have extensive knowledge in this area and can explain the various factors that can affect the tax you owe on dividends. Let's dive into the concepts mentioned in this article.
Taxation of Dividend Income
Dividend income is generally taxable, but the tax rate can vary depending on several factors. These factors include your taxable income, the type of dividend, and the type of account that holds the investment. Let's explore each of these factors in more detail.
Factors Affecting Dividend Taxation
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Taxable Income: Your taxable income plays a significant role in determining the tax rate on dividends. If your taxable income falls into the three lowest U.S. federal income tax brackets, you may not owe any income tax on dividends earned. The income thresholds for these brackets vary depending on your filing status and may change from year to year.
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Type of Investment Account: The type of investment account you hold can also impact the taxation of dividends. Dividends earned in retirement accounts such as Roth IRAs, traditional IRAs, or 401(k)s are generally not taxed since the income or realized capital gains in these accounts are tax-deferred or tax-free. However, there may be exceptions to this tax immunity for certain pass-through entities like master limited partnerships.
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Type of Dividend: The type of dividend received can affect the tax rate. Qualified dividends are eligible for lower tax rates, while nonqualified or ordinary dividends are taxed at your ordinary income tax rate. Certain types of distributions, such as returns of capital, may not be taxable in the current year but can impact your future taxes by increasing your capital gain on the stock.
Determining the Tax on Dividends
To determine the tax owed on dividends, consider the following factors:
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Type of Investment Account: Dividends earned in taxable brokerage accounts are generally subject to tax. However, dividends from retirement accounts (e.g., Roth IRAs, 401(k)s) or college savings plans (e.g., 529 plans) may not be taxable. Some exceptions exist, such as certain pass-through entities that can create tax obligations even for retirement accounts.
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Type of Dividend: The tax rate on dividends depends on whether they are qualified or nonqualified dividends. Qualified dividends are taxed at favorable rates, while nonqualified dividends are taxed at your ordinary income tax rate. Nontaxable distributions, such as returns of capital, are not subject to tax.
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Taxable Income: Your tax bracket determines the tax rate applied to dividends, whether qualified or ordinary. If your taxable earnings fall into the three lowest federal income tax brackets and you receive qualified dividends, you may not owe tax on those dividends.
Tax Rates on Dividends
The tax rates on dividends can vary based on your taxable income and filing status. Here are the tax rates for qualified and ordinary dividends in 2023:
Qualified Dividend Tax Rates:
- 0% for taxable earnings up to $44,625 (single), $89,250 (married filing jointly), and $59,750 (head of household)
- 15% for taxable earnings between $44,625 and $492,300 (single), $89,250 and $553,850 (married filing jointly), and $59,750 and $523,050 (head of household)
- 20% for taxable earnings over $492,300 (single), $553,850 (married filing jointly), and $523,050 (head of household)
Ordinary Dividend Tax Rates:
- Ranging from 10% to 37% based on taxable earnings and filing status
Net Investment Income Tax
High earners with modified adjusted gross incomes above $200,000 (single) or $250,000 (married filing jointly) may be subject to the Net Investment Income Tax. This additional 3.8% tax applies to dividend income and realized gains, regardless of whether the dividends received are classified as qualified or ordinary.
Conclusion
In summary, dividends are generally taxable, but the tax rate depends on factors such as your taxable income, the type of dividend, and the investment account holding the stocks. Qualified dividends may be taxed at lower rates, while nonqualified dividends are taxed at your ordinary income tax rate. It's important to consider these factors when determining the tax owed on dividends. Remember to consult a tax professional or refer to the IRS guidelines for specific tax advice tailored to your situation.
