Not all investments pay dividends. If yours do, make sure you understand how they'll be taxed.
POINTS TO KNOW
- Dividends are payments to owners of stocks, mutual funds, or ETFs.
- Your tax rate on dividends depends both on how long you've owned the shares and on your tax bracket.
What are dividends?
Dividends are payments of income from companies in which you own stock. If you own stocks through mutual funds or ETFs (exchange-traded funds), the company will pay the dividend to the fund, and it will then be passed on to you through a fund dividend.
Because dividends are taxable, if you buy shares of a stock or a fund right before a dividend is paid, you may end up a little worse off.
Good to know!
Funds that own foreign stocks may have to pay foreign taxes on dividends. They can elect to pass through those taxes to shareholders, reducing the dividend amount. If you're in this situation, the amount of foreign tax paid may then be used to offset your U.S. tax liability.
Note that when you view dividend amounts on vanguard.com, these taxes will already have been deducted. On your tax forms, the total dividend amount (before taxes) and the amount of taxes deducted will be reported as separate line items.
What are qualified dividends?
Dividends can be "qualified" for special tax treatment. (Those that aren't are called "nonqualified.") Most payments from the common stock of U.S. corporations are qualified as long as you hold the investment for more than 60 days.
Stocks of foreign companies traded through American Depositary Receipts (ADRs) or on U.S. markets may also be qualified.
In order for dividends passed through by a fund to be qualified, the fund must first meet the more-than-60-days requirement for the individual securities paying the dividends. Additionally, the owner of the fund must own the fund shares for more than 60 days.
What's the tax rate on dividends?
Qualified dividends are subject to a 0%, 15%, or 20% tax rate, depending on your income tax bracket.
10% or 15%
28%, 33%, or 35%
Dividends that are nonqualified are taxed at your usual income tax rate.
How are dividends reported?
Dividend income is reported to you and to the IRS on Form 1099-DIV.
How investments are taxed
Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.
A certificate issued by a U.S. bank that represents one or more shares in a foreign stock. ADRs are denominated in U.S. dollars and traded on U.S. exchanges and hence can be a cheaper and easier way to invest in individual international stocks.