4 Important Questions Regarding Taxes on Dividends

Buy a stock that pays a dividend, and a company pays you passive income every quarter in the U.S. and semi-annually in most other countries. 

However, in most cases, everyone must pay taxes on dividends. In the U.S. and most other countries, for that matter, dividends are considered income, and hence they are taxed. 

In the U.S., though, dividends can have favorable tax treatment for many small investors, making them tax efficient in regular brokerage accounts. 

Why do Investors Love Dividends So Much?

When a company pays a dividend, the investor decides what to do with that money. You can reinvest the money and buy additional shares of the same company. Alternatively, you can purchase shares of a different company. A third option is that you can keep the cash and do something else with it. 

What is the Tax Rate on Dividends?

Families in the highest income tax bracket pay a 37% tax rate on regular income and only a 20% tax rate on dividends. For families closer to the median U.S. family income of about $67,521 in 2020, the tax rate on regular income is 12%, but it is 0% on dividends. Think about it; you pay no income on your dividends. 

Can You Avoid Taxes on Dividends?

In general, the answer is no, but there are exceptions. Dividends are a type of income, so they are taxable. Reinvesting dividends in the same stock or mutual fund or ETF, for that matter, does not avoid taxes. You must still pay taxes on the dividends.