How Capital Gains and Dividends Are Taxed Differently

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How Capital Gains and Dividends Are Taxed Differently

Dividends are income generated by investing in stocks, mutual funds, or exchange-traded funds, and are reported on Schedule B of Form 1040. Capital gains are the difference in value between when an asset is acquired and when it is sold. Dividends and short-term capital gains are treated similarly in the United States, as are qualifying dividends and long-term capital gains.

Key Takeaways

  • Dividends and capital gains earned by investors are subject to taxation.
  • Short-term capital gains and ordinary dividends are taxed at the current income tax rate level, just like income.
  • Long-term capital gains and qualifying dividends are subject to lower tax rates than regular income.

Taxing Capital Gains

Capital gains tax rates are generally lower than income tax rates, and they are determined by how long the seller owned or kept the item. Short-term capital gains on assets held less than a year are nevertheless subject to regular income taxation. Long-term capital gains are more favourable if you own an asset for longer than a year. Depending on your income level, these rates are 0%, 15%, or 20%.

Long-term capital gains are taxed at 0% if your total income is $40,400 or less, 15% if your total income is $445,850 or less, and 20% if your total income is more than $445,850.

For 2022, the long-term capital gains tax rate is 0% if your income is less than $41,675, 15% if your income is less than $459,750, and 20% if your income is higher than $459,750.

It is important to note that capital losses may be used to balance capital gains in a particular tax year, decreasing the effective tax due—however, only short-term losses can counter short-term profits, and only long-term losses can offset long-term gains.

  Direct Tax Definition, History, and Examples

Taxing Ordinary Dividends

Ordinary dividends are regarded the same as short-term capital gains; those on assets held for less than a year are taxed at the individual’s marginal tax rate. Qualified dividends and long-term capital gains, on the other hand, benefit from a lower rate. Qualified dividends are those paid by domestic or qualified foreign corporations and held for at least 61 days out of the 121-day period commencing 60 days before the ex-dividend date.

Taxing Qualified Dividends

Qualified dividends are taxed in the same way as long-term capital gains. Individuals in the 10% to 12% tax band will continue to be tax-free in 2021 and 2022. Investors in the intermediate brackets—22%, 24%, 32%, or 35%—pay no more than 15% in capital gains. The wealthiest incomes, including those in the top 35% and 37% tax brackets, pay 20% in capital gains.

As a result, whereas dividends and capital gains are separate forms of investment income, they are taxed similarly.

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