Author Topic: Is There a Way to Stop Double Taxation?  (Read 4647 times)

oldtoyota

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Is There a Way to Stop Double Taxation?
« on: November 07, 2013, 07:42:11 PM »
I was reading on Vanguard.com about distributions, and it says this:

"Consider taking, rather than reinvesting, dividends and capital gains distributions from your taxable accounts. This provides income and can save on taxes. If you reinvest in taxable accounts, you'll likely have to pay taxes again when you later withdraw the money."

https://personal.vanguard.com/us/insights/retirement/living/retirement-income-withdrawal-strategy

While saving for retirement, I though that reinvesting dividends, etc was better than not. However, it sounds like I'll be taxed again on money I already paid taxes on, which is not fun at all.

Any legal way to get around that?

destron

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Re: Is There a Way to Stop Double Taxation?
« Reply #1 on: November 07, 2013, 07:51:26 PM »
Not that I know of.

You will either be double taxed on your dividends, or you could invest more money from your paycheck (assuming you are still working) and get taxed at a higher rate. Generally speaking, it is better to have your investments that give off income in a tax-preferred account to avoid this problem. Once in retirement, I would guess you would use your dividends first before selling off stock.

chasesfish

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Re: Is There a Way to Stop Double Taxation?
« Reply #2 on: November 07, 2013, 07:52:04 PM »
I think they're saying if you're going to need the money in that year, don't reinvest the dividend.

You only pay additional taxes on the increase in value.  The bigger reason not to reinvest a dividend when you need the income is it messes with your first in, first out cost basis. 

For example, if you own $10,000 of a position you've had a 100% gain in.
- take the $300 dividend, only pay qualified dividend rates
- reinvest the dividend, then sell $300 of your position.  You're paying capital gains taxes on the increase in value of your earliest position.  You also still owe the tax on the dividend you received, increasing your overall tax bill.

I don't like how vague the article is, that's my only interpretation.

xocotl

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Re: Is There a Way to Stop Double Taxation?
« Reply #3 on: November 08, 2013, 08:03:39 AM »
I think they're saying if you're going to need the money in that year, don't reinvest the dividend.

You only pay additional taxes on the increase in value.  The bigger reason not to reinvest a dividend when you need the income is it messes with your first in, first out cost basis. 

For example, if you own $10,000 of a position you've had a 100% gain in.
- take the $300 dividend, only pay qualified dividend rates
- reinvest the dividend, then sell $300 of your position.  You're paying capital gains taxes on the increase in value of your earliest position.  You also still owe the tax on the dividend you received, increasing your overall tax bill.

I don't like how vague the article is, that's my only interpretation.

That's the only sense I can make of it as well. And even the problem you mention, you can get around by specifying which lots you're selling instead of using FIFO, and specify the ones with the highest basis (which will probably be the ones you bought with your reinvested dividends). If you do that, you'll only be paying extra taxes to the extent that you actually made more money by reinvesting your dividends.

Kazimieras

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Re: Is There a Way to Stop Double Taxation?
« Reply #4 on: November 08, 2013, 02:52:01 PM »
While saving for retirement, I though that reinvesting dividends, etc was better than not. However, it sounds like I'll be taxed again on money I already paid taxes on, which is not fun at all.

Any legal way to get around that?

Invest using a tax-sheltered account, rather than a taxable one (Roth IRA or 401k - I think.... sorry Canuck here and my American tax accounts are rusty). That is the only legal way to get around the issue. It allows for the dividends to grow without taxation and to be reinvested at full value.

If you reinvest a dividend in a taxable account you will need to pay income tax on the dividend.

rogar

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Re: Is There a Way to Stop Double Taxation?
« Reply #5 on: November 08, 2013, 03:23:09 PM »
I'm not sure I follow the logic of being double taxed.  If you reinvest you are taxed on the dividend but you are essentially being new shares of stock at the going rate.  When you sell, you will only be taxed on the capital gain above the price you paid at the time of your reinvestment.

In my case, there is only so much I can get into tax deferred accounts.  I put the portion of my asset allocation that pays interest into the tax deferred accounts since interest is taxed as income rather than the capital gain rate, which is usually a lower rate.

oldtoyota

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Re: Is There a Way to Stop Double Taxation?
« Reply #6 on: November 09, 2013, 09:48:52 AM »
I think they're saying if you're going to need the money in that year, don't reinvest the dividend.

You only pay additional taxes on the increase in value.  The bigger reason not to reinvest a dividend when you need the income is it messes with your first in, first out cost basis. 


Thank you. How is the increase in value determined when I choose to reinvest the dividends? I want my taxable account to grow, so I do currently reinvest the dividends. If I did not, then the account would be stagnant in terms of growth.


oldtoyota

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Re: Is There a Way to Stop Double Taxation?
« Reply #7 on: November 09, 2013, 09:51:56 AM »
While saving for retirement, I though that reinvesting dividends, etc was better than not. However, it sounds like I'll be taxed again on money I already paid taxes on, which is not fun at all.

Any legal way to get around that?

Invest using a tax-sheltered account, rather than a taxable one (Roth IRA or 401k - I think.... sorry Canuck here and my American tax accounts are rusty).

No worries. You know a lot about American-style investing given you are Canadian. =-)

I do max out the 401Ks and the IRAs, so I am looking for where additional money should go. I am hoping to learn what I don't yet know about taxable accounts so I can make a good decision. Maybe I need to invest the extra in bonds. IIRC, it's best to put taxable accounts in bonds. Perhaps that is the answer??

seattlecyclone

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Re: Is There a Way to Stop Double Taxation?
« Reply #8 on: November 09, 2013, 02:58:23 PM »
I think they're saying if you're going to need the money in that year, don't reinvest the dividend.

You only pay additional taxes on the increase in value.  The bigger reason not to reinvest a dividend when you need the income is it messes with your first in, first out cost basis. 


Thank you. How is the increase in value determined when I choose to reinvest the dividends? I want my taxable account to grow, so I do currently reinvest the dividends. If I did not, then the account would be stagnant in terms of growth.



It's treated the same as if you just bought more shares for cash (because that's exactly what you're doing). You get a new block of shares with a new cost basis and purchase date. When you sell those shares you'll pay the appropriate long-term or short-term capital gains tax.

msilenus

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Re: Is There a Way to Stop Double Taxation?
« Reply #9 on: November 09, 2013, 06:31:29 PM »
Maybe I need to invest the extra in bonds. IIRC, it's best to put taxable accounts in bonds. Perhaps that is the answer??

Most bonds are worse than stocks in this respect.  The ideal taxable instrument is one that grows your capital without paying any distributions whatsoever, but distributions are the essential element of bonds. 

I'm not sure if there are any low-cost mutual funds or ETFs that invest exclusively in stocks that don't pay dividends, but it sounds like that's what you want.  Basically you're looking for companies that dump all their profits into new investments and/or share buybacks.