Do I Understand my Dividends and their Taxes?

[Scubatoad]

Hello Community,

I have been researching this topic for a while.  I think  I finally understand it - but wanted to confirm I am seeing things correctly.

I will use my specific life circumstances as an example:

I am married and file taxes jointly with my wife.  Together we make just less than 70K annualy - which I understand puts us in the 15% Federal income tax bracket.  We are from Washington State, so we also are not concerned with state income tax.

I understand that there are two types of Dividends - Ordinary and Qualified.  As far as I can tell - the only main difference is how long you have held the common stock.  If you have recently purchased the stock within 120 days of the payout it will be taxed as ordinary.  If you have had it longer than that, the dividend pays as qualified.  I understand there are some other stipulations here, but trying to simplify as much as possible.

I have owned some very common Dividend Paying stocks since January.  They reside in a taxable account.  For my upcoming September Dividend Payment, i believe this should be considered a qualified dividend payment.

Looking at the chart on wikipedia for Dividend Tax: http://en.wikipedia.org/wiki/Dividend_tax

It seems to me that these dividends will owe 0% tax since I fall into the 15% federal income tax bracket and I have owned the stock for 9 months. 

Do I understand this correctly - this is income that I will pay 0% tax on?

[matchewed]

For the most part I think you're correct. I do want to clarify about qualified dividends. It is not just 120 days of payout but that -

You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. Instead, the seller will get the dividend.

  When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it. See the examples later.

Source.

You are at the boarder of that 15% income bracket though. Make sure that no surprises happen pushing you to 25% or you'll be bumped up to 15% on the dividends.

[robotclown]

Yes.  0% tax on those dividends.  It's great!

It's actually based on holding it for 60 days out of the 121-day period starting 60 days before the ex dividend date.  So, if you buy it the day before the ex-div date, and hold it for 60 days, it's still qualified.  So any dividend you received since buying the stocks will be qualified, as you met the 60-day requirement.

Also note that a REIT's dividends are always ordinary, no matter how long you've held it, and MLP's have all sorts of complications as well.

[Scubatoad]

You are at the boarder of that 15% income bracket though. Make sure that no surprises happen pushing you to 25% or you'll be bumped up to 15% on the dividends.

This brings up another questions I had.  Lets say my wife and I make 69K this year through regualr salary.  However, lets also assume that our qualified dividends payed out 5k over the course of the year. 

Is that 5K considered regular income and could push us into the 25% bracket?  Or is that income filed seperately and has no effect on our tax bracket.

One of the concepts I am investigating originated fro the conversation that i read through in the comments of an old MMM article: http://www.mrmoneymustache.com/2011/12/22/guest-posting-from-dividend-mantra-what-is-dividend-growth-investing/

There is a debate about dividend income versus just selling stock for capital gain that do not pay dividends.  I was just trying to undertand why the poster "Dan" kept mentioning that Dividends are less efficient from a tax perspective.

[matchewed]

So qualified dividends, reported on line 1b for form 1099-DIV (source), would be put on line 9b on the 1040 (source). 9b is not added into the income column.

As for dividend income and the tax efficiency. The reason it is considered not tax efficient is because the money has already been taxed once as income prior to the investment. Consider your situation. You're paying 15% in taxes prior to the investment. If you can save up enough for your dividends to throw off consistent income then you've already been taxed at that rate. Depending on what we define as consistent income you could in theory be taxed again on that dividend income if you go over the amount or if dividend taxation changes (it will, how? I don't know, but it will).

Also Dan in the comments of that post is talking about things like tax loss harvesting which may or may not jive with a dividend strategy (usually doesn't) as you would have to sell positions in order to tax loss harvest therefore you will have lower dividends since you've sold positions. I'd sit down and read some investing books on these various things like MMM mentioned in that same article. If you don't grasp the nuts and bolts of a strategy it probably isn't a good idea to pursue it until you do.

[MDM]

Note that the $73,800 limit for the 15% bracket is on taxable income.  You get to deduct your standard (or itemized) deduction, and you deduct your exemptions. 

For a couple with no children, that is $12,400 for the standard deduction and $7,900 for the exemptions: a total of $20,300.  So the total gross income can be $73,800 + $20,300 = $94,100 before getting into the 25% bracket.

[Wile E. Coyote]

So qualified dividends, reported on line 1b for form 1099-DIV (source), would be put on line 9b on the 1040 (source). 9b is not added into the income column.

Just to clarify, the amount that is on line 9b is already included in the amount on line 9a, so it is not correct to say that the amount on line 9b is not included in the calculation of adjusted gross income.  However, the qualified dividends are backed later when computing tax liability, and the tax on qualified dividends is computed separately.

[matchewed]

So qualified dividends, reported on line 1b for form 1099-DIV (source), would be put on line 9b on the 1040 (source). 9b is not added into the income column.

Just to clarify, the amount that is on line 9b is already included in the amount on line 9a, so it is not correct to say that the amount on line 9b is not included in the calculation of adjusted gross income.  However, the qualified dividends are backed later when computing tax liability, and the tax on qualified dividends is computed separately.

Yarp I got it wrong on my review. :)

[Scubatoad]

I really appreciate the responses!

As my quest for a financial strategy for my earnings above my expendatures has lead me to this site - I have continously realized that I am spending more and more time learning this giant web of tax law.

Somehow I want to blame my K-12 and 4 years in college for not having really any finance information as a mandatory study.  However, I would probably guess that I would have been looking out the window at the green grass baking in the sun even if they did.  As this information really only becomes useful and applicable when you have earnings above expendatures.

I suppose I will really need to buckle down and push through some of the books reccomended.  I just generally have a fear when it comes to books that they are possibly old and have information that is out of date.

That is generally why I have more faith in these living blogs and forums.

[matchewed]

Yeah investing books will not have up to date tax information. But I would take investing advice separate from taxation first. First you learn the ins and outs of investing. Then evaluate the impact taxation has on it. Worrying about taxation right now isn't going to be super helpful as you may just start to suffer from analysis paralysis. Save save save and learn.

[Scubatoad]

Yeah investing books will not have up to date tax information. But I would take investing advice separate from taxation first. First you learn the ins and outs of investing. Then evaluate the impact taxation has on it. Worrying about taxation right now isn't going to be super helpful as you may just start to suffer from analysis paralysis. Save save save and learn.

I have been hanging around here and some other blogs for the past 6 months or so.  I have always been a natural saver - but I never made a significant ammount of money to invest. 

I think I have a pretty good grasp on a lot of the investing concepts and a good idea of a lot of the pros and cons. (I will continue to be a life-long learner)  I am now at the point where I am really trying to compare different strategies and how they impact my current life situation.  i want to calculate my own numbers and not just run off with an example that someone else used, or by using some sort of a simulator that I do not understand its under-the-hood algorithms.

At first I was just looking at hpyothetical investments and how they pan out, but I realized quickly that tax plays a large factor in a lot of these long-term calculations.

It is true though - at times I can get very frustrated with all the investment tactics and then adding different tax situations to them.  I understand why a lot of people just want to hire their own investment advisors from a purely analytical standpoint.

[matchewed]

Yeah investing books will not have up to date tax information. But I would take investing advice separate from taxation first. First you learn the ins and outs of investing. Then evaluate the impact taxation has on it. Worrying about taxation right now isn't going to be super helpful as you may just start to suffer from analysis paralysis. Save save save and learn.

I have been hanging around here and some other blogs for the past 6 months or so.  I have always been a natural saver - but I never made a significant ammount of money to invest. 

I think I have a pretty good grasp on a lot of the investing concepts and a good idea of a lot of the pros and cons. (I will continue to be a life-long learner)  I am now at the point where I am really trying to compare different strategies and how they impact my current life situation.  i want to calculate my own numbers and not just run off with an example that someone else used, or by using some sort of a simulator that I do not understand its under-the-hood algorithms.

At first I was just looking at hpyothetical investments and how they pan out, but I realized quickly that tax plays a large factor in a lot of these long-term calculations.

It is true though - at times I can get very frustrated with all the investment tactics and then adding different tax situations to them.  I understand why a lot of people just want to hire their own investment advisors from a purely analytical standpoint.

While I don't disagree that tax is a large factor in long-term calculations, taxes will change in the long-term. Only focus on taxes impacts on the now or very near term. Trying to anticipate tax implications >4 years out will be impossible. It is why I encourage the three major categories for investing; traditional 401k's and IRA's, Roth IRA's, and taxable investments. Now you'll have the tools to deal with long term plans with (nearly) any tax scenario.

[electriceagle]

Also note that a REIT's dividends are always ordinary, no matter how long you've held it, and MLP's have all sorts of complications as well.

Folks who buy MLPs often do so because of those complications. Often, an MLP's distributions are part-earnings (taxable) and part return of capital via depreciation (non-taxable).

[Joel]

Keep in mind, if you have long term capital gains or qualified dividends and you are bordering the 15% and 25% marginal tax rates, you can actually encounter a position where you have a 30% marginal tax rate. For example, when one additional dollar of ordinary income is taxed at 15% and it bumps one additional qualified dividend or long term capital gain dollar to also be taxed at 15%.

I'm currently in this situation and pay close attention to my IRA contributions to make sure I stay out of the 25% marginal tax bracket.

[Workinghard]

Note that the $73,800 limit for the 15% bracket is on taxable income.  You get to deduct your standard (or itemized) deduction, and you deduct your exemptions. 

For a couple with no children, that is $12,400 for the standard deduction and $7,900 for the exemptions: a total of $20,300.  So the total gross income can be $73,800 + $20,300 = $94,100 before getting into the 25% bracket.

Thanks for pointing this out! I totally missed it before. It increases the amount  we can convert to Roths before going to a higher tax bracket.