If I Reinvest My Dividends, Are They Still Taxable?

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If I Reinvest My Dividends, Are They Still Taxable?

Dividends are paid by some of the world’s biggest and most successful corporations. Dividends are payments provided by corporations to their shareholders based on their profitability. These businesses successfully reward their investors by distributing a share of their profits. This stream of income, no matter how modest, is one of the reasons why dividends are so popular among investors.

But what should you do with your profits once they arrive? Should you withdraw them or reinvest them? Cashing them out adds complications since they might be classified as both qualifying dividends and regular dividends. Understanding how dividends are classified is essential for making an educated choice about whether to reinvest or cash out for tax reasons. In this post, we’ll look at how these categories are taxed so you can make an educated choice about how to handle your dividends.

Key Takeaways

  • Dividends are payments provided by corporations to their shareholders based on their profitability.
  • Dividends may be reinvested or received in cash by investors.
  • Cash dividends are classified as either qualified or ordinary.
  • Ordinary dividends, which are considered ordinary income, are taxed at higher rates than qualified dividends.
  • Dividends that have been reinvested are taxed as if you had received the cash.

Taxes on Qualified Dividends

A cash dividend may be classified into two types: qualified dividends and unqualified dividends. This form of payout is taxed at a lower rate than regular income. As a result, investors must pay the relevant capital gains tax rate on qualifying dividends. A capital gain is a rise in the value of a capital asset, such as real estate or an investment, above the original purchase price.

Qualified dividends meet several key criteria:

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  • They must be compensated by a qualified American or international enterprise.
  • They are not permitted to be unqualified dividends.
  • They must complete the holding period (61 days during the 121-day period as of the 60 days before the ex-dividend date or 91 days out of the 181-day period for preferred stock)

The tax rate on a qualifying dividend, and hence the amount of tax you owe, is determined by your yearly income. The figure below summarizes capital gains tax rates, yearly income criteria, and filing status.

Capital Gains Tax RateAnnual Income RangeFiling Status
0%$0 to $40,400Single
$0 to $80,800Married Filing Jointly
15%$40,400 to $445,850Single
$40,400 to $250,800Married Filing Separately
$54,100 to $473,750Head of Household
$80,800 to $501,600Married Filing Jointly

Source: Internal Revenue Service

For filers who surpass the 15% threshold, the Internal Revenue Service (IRS) applies a 20% capital gains tax rate.

Dividend-paying corporations transmit Form 1099-DIV: Dividends and Distributions to shareholders. Box 1b reports qualified dividends. These should be entered on line 3a of your Form 1040.

There is a distinction to be made between realized and unrealized capital gains. A gain is not realized until the asset is sold, and taxes are usually not paid until the gain is realized.

Taxes on Ordinary Dividends

The other sort of cash payout is an ordinary dividend. Dividends are often regarded as ordinary by default. Those that do not fulfill the qualifications for qualifying dividends are taxed as ordinary income. This category of revenue also includes earnings from wages, salaries, commissions, and bond interest.

The following aren’t considered qualified dividends:

  • Capital gains distributions
  • Any profits paid on deposits held by credit unions and other financial entities
  • Any dividends paid by a charitable organization or other tax-exempt company
  • Dividends paid by a company on assets held by an employee in the business’s employee stock ownership plan
  • Dividends on stock that compel the holder to make relevant payments
  • Foreign corporation dividends
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Regular dividends are taxed at your marginal tax rate since they are treated as ordinary income. In the United States, the tax rates for 2022 are as follows:

2022 Marginal Tax Rates
Tax RateIncome Range (Single)Income Range (Married Filing Jointly)
10%$10,275 or less$20,550 or less
12%$10,276 to $41,775$20,551 to $83,550
22%$41,776 to $89,075$83,551 to $178,150
24%$89,076 to $170,050$178,151 to $340,100
32%$170,051 to $215,950$340,101 to $431,900
35%$215,951 to $539,900$431,901 to $647,850
37%$539,900 and above$647,850 and above

Source: Internal Revenue Service

Form 1099-DIV will be sent to you by the firm that pays you regular dividends. Box 1a reports ordinary dividends. These should be entered on line 3b of your Form 1040.

You may use standard deductions to offset your regular income. Capital gain income, on the other hand, can only be offset by capital loss.

Taxes on Dividend Reinvestment

Some people choose to reinvest their dividends. This is a method of automatically purchasing new shares in the same firm using cash dividends rather of paying them out to the investor. However, if you believe you are exempt from paying taxes on your reinvested profits, think again.

Reinvesting your dividends is the same as getting them in cash. And how they are taxed differs depending on whether they are considered ordinary or qualified. Remember that your dividends must fulfill specific conditions in order to be considered qualified, which means they will be taxed at the capital gains rate. Ordinary dividends are taxed like ordinary income when reinvested.

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This includes any dividend reinvestment plans (DRIPs) in which you have an interest. DRIPs enable investors to buy more stock at below-market prices. The difference between the cash reinvested and the stock’s fair market value (FMV) is taxed as regular dividend income in certain instances.

Keep in mind that certain firms do not allow investors to withdraw funds. Instead, these corporations pay dividends to shareholders exclusively in the form of extra shares. When received, these stock dividends are not taxed. Rather, when they sell their shares, investors pay taxes. If an investor has the choice of taking cash or shares but selects cash, they are taxed appropriately.

Are Reinvested Dividends Taxable?

Dividends reinvested are regarded the same as cash dividends. The manner in which they are taxed is determined by whether they are deemed ordinary or qualified dividends. If you join in a dividend reinvestment plan, you may only owe taxes on the difference between the shares’ fair market value and the purchase price, which is often less than market value. This sum is subject to ordinary income taxation.

How Do You Pay Taxes on a Fund That Reinvests Dividends?

Dividends are taxable whether received in cash or reinvested in the mutual fund that pays them out. The tax burden is incurred in the year in which the dividends are reinvested. Assuming the firm enables you to buy shares at below-market prices, you’ll only pay ordinary income on the difference between the fair market value and the purchase price (if they’re not regarded eligible dividends).

How Are Reinvested Dividends Taxed if the Security Is Sold?

You must pay taxes on any assets sold, including those previously reinvested. Your tax rate is determined by the length of time you owned the shares and whether the dividends were qualified or ordinary.

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