How to Avoid Paying Dividend Taxes

(3DConcepts/Shutterstock)

Receiving dividends regularly provides an excellent opportunity to earn more money. If you are retired, the money can supplement your income and make it more comfortable. The good news is that there are some tactics you can use to avoid dividend taxes.

The Capital Gains Tax Rate

Taxes on dividends partially depend on how much income you get each year. Because there is a capital gains tax threshold, it is possible to avoid paying any taxes on your dividends if you make below a certain amount. The Internal Revenue Service (IRS) says that in 2022 a single person can make up to $41,675 and not pay any capital gains taxes, and a married couple filing jointly can earn up to $83,350. A head of household can make up to $55,800 and avoid paying any capital gains tax.

The tax rate goes up when your income is higher than the above amounts. The taxes jump to 15 percent when the income for a single person ranges from $41,675 to $459,750, and when married couples filing jointly earn between $83,350 and $517,200. Any income higher than the amounts above are taxed at 20 percent.

Limitations on Your Losses

If you have investments in stock or other tools that result in losses, there is a limit on how much you can claim. When your losses are greater than your capital gains, you can use them to lower your taxable income. Losses up to the smaller amount of $3,000, or the actual loss amount, can be reported on line 16 of a Schedule D on your 1040 taxes. You can claim any losses greater than $3,000 on future taxes.

Qualified dividends have the benefit of being taxed at a lower rate than your ordinary income—which could be taxed as high as 37 percent. These stocks are held longer than the required holding period. The company, U.S. or foreign, will be listed on one of the major stock exchanges.

Identifying whether your dividends are qualified or non-qualified is not difficult. BusinessInsider says you can tell the difference by whether your annual 1099-DIV reports your dividends and any other distributions in Box 1a or 1b. You can find the qualified dividends in Box 1b.

Reinvesting Your Dividends

One option with your dividends is to reinvest them and buy more stock. Investopedia says it is a mistake to think you can avoid paying taxes on the gains by reinvesting.

The IRS treats those dividends the same as if you had received cash. If they were ordinary dividends—even though the money was reinvested—you will be taxed on the money as income.

Avoiding the Capital Gains Tax on Dividends

Instead of paying the required capital gains tax on your dividends, there are several ways to avoid them.

• Roth Retirement Accounts

When you contribute money to a Roth account, you have already paid taxes on it. It enables you to earn interest on your Roth account and not have to pay taxes on the interest or when you make a withdrawal. You need to have the account opened for at least five years and be at least 59½ to avoid any taxes and penalties.

• Select Investments

Investing in a Roth IRA or a Roth 401(k) can also enable you to avoid taxes on your dividends. Selecting stocks, EFTs, or mutual funds within those accounts enables you to get tax-free money when you follow the guidelines for withdrawals.

• Education Accounts for Children

Helping to send your children or grandchildren to college can help them get the education they need in today’s world. Two accounts you can invest in to help them are the 529 Plan and the Coverdell Education Savings Account. These accounts build interest and pay dividends. You will not pay any tax on them until the money is withdrawn, but when it is used for education, there are no taxes. The 529 Plan typically grows about 5 percent per year.

LendingTree says that more than 30 states offer tax deductions or credits for contributions to a 529 Plan. They may vary in the amount of the permitted deduction and contribution limits, but you can invest in plans outside of your state.

• Nontaxable Dividends

You can also ensure that you will not pay any taxes on your dividend income by buying nontaxable stock. This kind of stock is sold as a municipal bond. If you live in the state where the bond was issued—and your state has no state income tax—the dividends and interest are tax-free. There usually is no federal income tax on municipal bonds. You can also put money into mutual funds that invest in municipal bonds.

If you are looking to build your wealth, this may not be the type of bonds you want to invest in. Investopedia reports that they generally have lower interest rates than taxable securities. When you want to build your wealth, you are better off investing in ordinary stock.

Consider Aftertax Charges

When considering where to invest your money, you must think about more than just the profit. Fidelity advises that you should also consider what your final yield will be after looking at pre- and after-taxes. By looking at both before you invest, you may be able to keep more money.

If you need help finding the best ways to avoid taxes on your dividends, talking to a financial planner can help. They can show you some excellent investment strategies and how to avoid paying taxes.

The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.