I don't think that's the full story. Say I bought some number of shares >1 year ago, enrolled in dividend reinvestment, and at the end of 2016 sold all of that security. Whatever gains I had made through dividend reinvestment during 2016 would be subject to the short term capital gains tax. It seems to me that my tax bill would be smaller and simpler if I opted out of dividend reinvestment, and instead just tacked on that few extra dollars to my next purchase (which I would then hold onto for >1 year). At least for my tax bracket (15% short term, 0% long term), and my at-least-monthly frequency of making new investments, dividend reinvestment wouldn't make sense.
No need to make assumptions here. It's all math. Show us your math on both scenarios, and if you don't see your mistake, we'll point it out :)
Thanks to all for continuing the discussion. I'm not sure of the math, and my situation is different than supermatthew because I'm in the 28% tax bracket. But here goes with some numbers:
1636 total shares, current share price 55.00, all sold at an avg cost basis of 25.00, and it was all long term gains.
1636*55=90000 (Rounded up for simplicity)
1636*25=40900 cost basis
90,000-42500 = 49100 in LTCG. 49100 *.15 = 7365 taxes owed. (if I waited one entire year and had turned off auto-reinvest)
Since I'm not making any new contributions but dividends are being reinvested, in 2015, let's say 25 shares were purchased via auto-reinvest. 1611 shares sold are LTCG, 25 are short term.
1611*$25=40275 (cost basis)
1611 shares long term = 1611*55=88605-40275=48830*.15=7324.00 in taxes owed
25 short term remain
25*$25=625
25*$55=1375
1375-625=750 short term gains *.28 = $210 taxes owed
7324+210 = 7534 in taxes owed (LTCG + short term)
all long term: 7,365.00
most long term, some short term 7,534.00
Not sure if the math is right, but wouldn't this suggest to turn off auto-reinvesting?
WP
It looks like your two scenarios are flawed. Here's what I think you were trying to do:
Scenario 1: Selling everything after 1 year. Dividends taken as cash, as reinvestment was turned off.
Scenario 2: Selling everything after 1 year. Dividends used to buy more shares, as reinvestment was turn on.
Is this the case? If so why do they both have the same # of shares at the end? Scenario 2 should have extra shares at the end. You started Scenario 1 with 1636 shares, and started Scenario 2 with 1611 shares, why? You only ended up at 1636 after taking into account the extra dividend shares.
Scenario 1 should have X number of shares +
some cash. Scenario 2 should have X number of shares +
extra shares from the dividend. If you did the math properly, you should only be comparing the difference between the two scenarios. Let's do that:
Both scenarios have 1611 total shares to start, taxed as Long Term Capital Gains, so let's ignore that and focus on the differences:
Dividends reinvested - 25 shares taxed as short term capital gains.Current dollar value: 25 (shares) times $55 (current price) = $1,375
Cost basis (to keep the math simple let's say price rose 10%, and steadily throughout the year): 25 (shares) times $52.50 (average cost basis) = $1,312.5
Taxable income: #1,375 - $1,312.5 = $62.5
Tax owed at 28% rate: $17.5
Total profit of dividend: $45
Dividends taken as cash - $1,312.50 (the same amount used in the above scenario to purchase shares)Taxable income: $0 (it's cash, and we refuse to invest it to avoid taxes)
Tax owed at 28% rate: $0
Total profit of dividend: $0
Again, you're only taxed on profits. It doesn't make sense to eliminate profits, simply to avoid taxes.