Dividends are a great way to earn passive income. If you invest wisely, dividends will grow over time and become a reliable source of income. Dividends can also help you save money on taxes. The tax rate on dividends varies based on your taxable income but the dividend tax rate is lower than your tax rate on ordinary income.
Your Guide To 2021 Tax Rate On Dividends
What Are Dividends
Dividends are a share of the profit that companies distribute to their shareholders. Most companies distribute dividends quarterly.
Dividends can be qualified or nonqualified dividends. Non-qualified dividends are sometimes called ordinary dividends.
Tax Treatment of Dividends
Tax treatment of dividends varies based on whether the dividend is qualified or nonqualified. Qualified dividends get preferential treatment when it comes to taxes. For nonqualified dividends, you will pay regular income tax.
According to the IRS, a dividend is considered a qualified dividend if you held the stock for at least 60 days during the 121-day period that extends 60 days before and after the ex-dividend date. If you don’t meet the holding period requirements, the dividends will be considered nonqualified dividends and will be taxed at a higher rate.
A stock’s ex-dividend date is the date it starts trading without the value of the next dividend.
At the end of the year, your stockbroker will break down dividends into qualified and nonqualified dividends on Form 1099. But it is up to you to meet the holding period requirements to make the dividends qualified, which will lower your taxes.
Dividend Tax Brackets
The following tables show the tax brackets for single and joint tax filers. These are taxable income limits. This means that you need to take your gross income and subtract your deductions before using this table.
Here is an example. Let’s say that you are married and are filing jointly. You have an annual income of $105,900, all of them in dividends. You can subtract your standard deduction of $25,100 and you will end up with a taxable income of $80,800. From the table below, you will see that your tax rate is zero.
That’s quite remarkable that you can make $105,900 in dividend income and not pay a dime in taxes. This shows how tax-efficient dividend investing can be.
|Qualified Dividend Tax Rate||Single Filers||Married Filing Jointly||Heads of Household||Married Filing Separately|
|20%||$445,851 or more||$501,601 or more||$473,751 or more||$250,801 or more|
Net Investment Income Tax (NIIT)
If you are a single filer and your modified adjusted gross income is over $200,000 or if you are a joint filer and your modified adjusted gross income is over $250,000, NIIT tax rate of 3.8% is applied on income from dividend income, interest income, short and longterm capital gains, taxable income from annuities, REITs, and Master Limited Partnerships.
The threshold amounts are not indexed for inflation but Congress could change that in the future. NIIT is a flat tax that you need to pay on top of your other taxes.
Dividend investing is a great way to earn passive income. Plan to hold your dividend investments long enough for them to be qualified dividends. Dividend investing can also be very tax efficient. A married couple making $105,900 in dividend income (and assuming no income from other sources) will not pay any taxes. If you are a high earner, you may need to pay Net Investment Income Tax (NIIT).
The information contained in this article is not tax or legal advice. Tax laws change frequently. So please consult with an accountant or an attorney.