How to Pay Taxes on Stock Market Dividends

Dividend payments on a large portfolio can add thousands of dollars to your bottom line each year. You can spend this cash to provide for day-to-day expenses, durable goods, or as a source of capital that can be reinvested back into the market to buy assets that compound additional wealth. Taxes on dividends, of course, will slow the wealth creation process. Before coordinating your investment strategy, it is critical that you become familiar with basic tax law as it relates to dividends.

Paying Taxes on Stock Market Dividends: Identification

You generally will owe taxes on dividends that you collect within regular taxable brokerage accounts. With a retirement account, however, you will enjoy tax deferral. Tax deferral means that you can bypass taxes on dividend income as they occur within the retirement account. With a 401(k) and Traditional IRA, you will make tax-deductible contributions, which will trigger ordinary income taxes at retirement. Alternatively, Roth IRA contributions are made with after tax money, which allows for tax-free withdrawals at retirement. Because of these rules, this article is specifically concerned with dividend payments related to taxable brokerage accounts.

Paying Taxes on Stock Market Dividends: Timing

When owning stock, you generally must take note of four separate sets of date each year, because dividends are paid quarterly. To collect dividends on the next payable date you must buy and hold shares prior to and through the ex-dividend date. On the payable date, you will receive dividends and owe taxes at that point. The dividend payable date typically falls one month after the ex-dividend date.

Paying Taxes on Stock Market Dividends: Ordinary vs. Qualified Dividends

For the 2010 tax year, dividends are classified as either ordinary or qualified dividends. Ordinary dividends are taxed at ordinary income rates of 10, 15, 25, 28, 33, and 35 percent. Qualified dividends are associated with favorable tax treatment and will be either tax free or taxed at 15-percent rates. For tax-free qualified dividends, you must report less than $34,000 and $68,000 in taxable income as a single and married filing jointly taxpayer, respectively. You will receive qualified dividends, if you own shares of stock for more than 60 out of the 120 days surrounding the stock's ex-dividend date.

Paying Taxes on Stock Market Dividends: Paperwork and Strategy

At tax season, you will receive a 1099-DIV form from your brokerage. The 1099-DIV summarizes your dividend payments and categorizes them into qualified and ordinary dividends. With this information, you will complete Schedule D and Form 1040 to report and pay taxes on your dividend payments to the IRS.

Remember, your ultimate goal when investing money is to earn the highest amount of return for the least amount of risk. Doing so does not always translate into a minimal tax bill. In terms of dividend payments, you should not hold on to a losing stock, simply to meet the holding period for qualified dividends.

Paying Taxes on Stock Market Dividends, Sources:

IRS: Dividends

IRS: Instructions for Form 1099-DIV

IRS: Retirement Plans FAQs Regarding IRAs

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