How Do I Avoid Paying Taxes on Dividends? (2024)

Dividends are payments that some companies make to shareholders to reward them for investing in them. Dividends can provide regular, predictable income to investors who also preserve the chance of profiting from price appreciation. Dividends can qualify for advantageous capital gains tax treatment if stocks are owned long enough. Avoiding all income taxes on dividends is more complicated, though. Options include owning dividend-paying stocks in a tax-advantaged retirement account or 529 plan. You can also avoid paying capital gains tax altogether on certain dividend-paying stocks if your income is low enough. A financial advisor can help you employ dividend investing in your portfolio.

Dividend Basics

Dividends are payments investors get from owning shares of some companies. Companies that are profitable may distribute some of their profits as cash payments or stock dividends as a way to reward shareholders for investing in the business. Dividend-paying stocks are popular alternatives to bonds for investors who want to generate passive income. Retirees often invest in dividends so they can pay their living expenses without having to sell stocks.

Like all income, dividends are subject to taxes. The tax rates depend on whether dividends are considered qualified or non-qualified. Ordinary or non-qualified dividends are paid by stocks that are owned for less than the required holding period. These dividends are taxed at an investor’s ordinary income tax rate. Qualified dividends, which are paid by stocks that are owned for at least the required holding period, are taxed as capital gains.

Capital gains rates are generally lower than ordinary income rates and fall into the rate bracket of 0%, 15% or 20%. Rates are based on the taxpayer’s income and most taxpayers are in the 15% capital gains bracket. As an example, an investor who earned $10,000 from qualified dividends typically would owe capital gains taxes of $1,500, reducing their after-tax gain to $8,500.

How to Avoid Taxes on Dividends

There are a few strategies for avoiding taxes on your dividends, depending on whether they’re qualified or ordinary dividends:

  • Roth retirement accounts: A Roth IRA is funded with after-tax money. Once a person reaches age59 ½, money can be withdrawn tax-free. So any dividends paid out by stocks owned in a Roth account would be free of taxes, as long as the dividends were withdrawn after age 59 ½ and at least five years after the account was opened.
  • Qualifying for zero capital gains tax: Capital gains taxes are graduated, with higher-income investors paying higher rates. Investors in the lowest income bracket owe zero capital gains taxes. Brackets change annually. For example, a married couple filing jointly with taxable income of $89,250 or less for the 2023 tax year would pay no capital gains tax on dividends. Strategies such as contributions to retirement accounts and health savings accounts (HSAs) may reduce your income below the zero-capital gains tax threshold. As a result, you wouldn’t owe any taxes on qualified dividends.
  • Education plans: Tax-advantaged 529 plans allow tax-free growth and withdrawals as long as the money is used to pay qualifying education expenses. So placing funds into a 529 plan and using the money to buy dividend-paying stocks will allow you to accumulate funds tax-free and also withdraw the money without owing taxes. However, this only works if the withdrawal amounts go for qualified education expenses such as tuition and books.
  • Other retirement accounts:Other retirement accounts, like traditional IRAsand 401(k)s can offer partial relief from income taxes. These accounts are funded with pre-tax money. An investor can deduct money contributed to a traditional account from their current taxable income. But unlike Roth accounts, withdrawals are taxed as ordinary income. Holding dividend-paying stocks in a traditional IRA or 401(k) won’t eliminate your tax liability, but it could reduce it.

Bottom Line

Investing in dividend-paying stocks can generate income while also preserving the potential for capital appreciation. Dividend income may be taxed at capital gains rates that are lower than tax rates on ordinary income as long as the shares are held for at least a year. You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.

Investing Tips

  • Consider checking with a financial advisor for suggestions about tax-efficient ways to generate income through dividend investing. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • To plan well for your financial future, you need to have some idea of how much your investments will be worth in the future. SmartAsset’s can help you estimate how much your portfolio could be worth. Provide the amount of money you’re starting with, the additional contributions you plan to make, your expected rate of return and how long you want to let the money grow. The calculator will then give you the future estimated value of your portfolio.

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How Do I Avoid Paying Taxes on Dividends? (2024)

FAQs

How Do I Avoid Paying Taxes on Dividends? ›

Options include owning dividend-paying stocks in a tax-advantaged retirement account or 529 plan. You can also avoid paying capital gains tax altogether on certain dividend-paying stocks if your income is low enough. A financial advisor can help you employ dividend investing in your portfolio.

How do you avoid paying tax on dividends? ›

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.

How do I live off dividends without paying taxes? ›

You can reduce taxes while you're working by building your dividend portfolio within a tax-advantaged retirement account. The dividends themselves won't be taxable, but you will pay taxes on withdrawals from traditional IRA and 401(k) accounts.

How to get dividends tax-free? ›

There are several investment vehicles and account types that allow many investors to earn tax-free or tax-advantaged dividend income. Some of the most popular options include municipal bonds, Roth IRA investments and Health Savings Accounts (HSAs).

How do I avoid US withholding tax on dividends? ›

Under the Treaty, there is a special exemption from U.S. withholding tax on interest and dividend income that you earn from U.S. investments through a trust set up exclusively for the purpose of providing retirement income. These trusts include RRSPs, RRIFs, LIRAs, LIFs, LRIFs and Prescribed RRIFs.

Do dividends count as income? ›

Key Takeaways. All dividends paid to shareholders must be included on their gross income, but qualified dividends will get more favorable tax treatment. A qualified dividend is taxed at the capital gains tax rate, while ordinary dividends are taxed at standard federal income tax rates.

Do dividends have to be reported to IRS? ›

If you had over $1,500 of ordinary dividends or you received ordinary dividends in your name that actually belong to someone else, you must file Schedule B (Form 1040), Interest and Ordinary Dividends. Please refer to the Instructions for Form 1040-NR for specific reporting information when filing Form 1040-NR.

Do retirees pay taxes on dividends? ›

Retirement tax rates by income source

Long-term investment gains, including qualified dividends, are taxed at the long-term capital gains rate (plus a potential 3.8% net investment income tax).

Does reinvesting dividends avoid tax? ›

Keep in mind: You can't avoid taxes by reinvesting your dividends. Dividends are taxable income whether they're received into your account or invested back into the company.

Is it realistic to live off dividends? ›

The Bottom Line

By investing in quality dividend stocks with rising payouts, both young and old investors can benefit from the stocks' compounding, and historically inflation-beating, distribution growth. All it takes is a little planning, and then investors can live off their dividend payment streams.

What kind of dividends are not taxable? ›

Nontaxable dividends are dividends from a mutual fund or some other regulated investment company that are not subject to taxes. These funds are often not taxed because they invest in municipal or other tax-exempt securities.

How much tax will I pay on my dividend income? ›

How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.

Are reinvested dividends taxed twice? ›

Dividends are taxable regardless of whether you take them in cash or reinvest them in the mutual fund that pays them out. You incur the tax liability in the year in which the dividends are reinvested.

Who pays withholding tax on dividend? ›

While the U.S. government taxes dividends paid by American companies, it doesn't impose tax withholdings for U.S. residents. In other words, each U.S. investor receives the full dividend amount and is responsible for reporting their annual dividends to the IRS each year and paying taxes accordingly.

How much is US dividend withholding tax? ›

If you're looking to build a dividend portfolio but don't want to have your income eaten up by the 30% US dividend withholding tax, then invest elsewhere. Refer to the table above for countries that do not charge a dividend withholding tax.

How do I report tax exempt dividends on 1040? ›

Also include on line 2a of your Form 1040 or 1040-SR any exempt-interest dividends from a mutual fund or other regulated investment company. This amount should be shown in box 12 of Form 1099-DIV. If an amount is shown in box 9 of Form 1099-INT, you must generally report it on line 2g of Form 6251.

What stock dividends are not taxable? ›

If shares are held in a retirement account, stock dividends and stock splits are not taxed as they are earned. 1 Generally, in a nonretirement brokerage account, any income is taxable in the year it is received.

What can offset dividend income? ›

If your losses are greater than your gains

Up to $3,000 in net losses can be used to offset your ordinary income (including income from dividends or interest). Note that you can also "carry forward" losses to future tax years.

Do you pay taxes on all dividends? ›

Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%. IRS form 1099-DIV helps taxpayers to accurately report dividend income.

Are dividends taxed when declared or paid? ›

Investors pay taxes on the dividend the year it is announced, not the year they are paid the dividend.

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