A dividend-paying stock can be an attractive investment because it provides income on a regular basis. If the stock doesn't go up in value, investors still earn a return from the dividend. As with most income, dividends from stocks are taxable, as are any capital gains they generate. The specific tax consequences of the stock depend on the nature of the dividend and its capital gains.
Most dividend payments from corporations are taxed at your marginal rate as ordinary income. If they're significant enough, they could move you into a new tax bracket depending on your other income. The best way to know if your dividends are considered ordinary is to check the Form 1099-DIV issued by the company. If you've got some figures in box 1a of that form, you've got "ordinary" dividends.
Some dividend payments are qualified dividends and receive a more favorable tax rate. If you can buy dividend-paying stocks that issue qualified dividends, you'll owe less money at tax time. Qualified dividends only get that status if they meet certain criteria set up by the Internal Revenue Service. The easiest way to know if your dividends are qualified is to look at your year-end 1099-DIV form, where they'll appear in section 1b. As of 2012, qualified dividends are taxable at either 15 percent or 0 percent, depending on whether or not your marginal tax rate is 25 percent or higher.
If you sell your dividend-paying stock at a profit, you'll be responsible for capital gains tax. Short-term capital gains, or assets held for one year or less, are taxable at ordinary income rates, same as ordinary dividends. If you hold on to the stock for more than a year, it qualifies for the long-term capital gains rate. As of 2010, the maximum capital gains tax rate for most people was 15 percent. For those in the lowest tax brackets, the capital gains rate was 0 percent.
If you hold your dividend-paying stocks in a retirement account, such as a 401(k) plan or an individual retirement account, you don't have to worry about paying taxes until you withdraw the money. All dividends, interest and capital gains earned in a retirement account are tax-deferred until distribution, at which time they become fully taxable at ordinary income rates. The exception is a Roth account. Its distributions are typically tax-free.
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