This upcoming weekend, in honor of President’s Day, I decided I’d use the holiday off from work to get my income taxes completed. In preparation for filing my taxes, I started making a list of all of the different tax documents I need to make sure I have ready so I can hopefully make the process as painless as possible.
Since I am a dividend growth investor and I invest in stocks through a taxable brokerage account, I need to make sure I have received all the proper forms from my broker. Let’s take a look at the different forms an investor can expect to receive and how their dividend growth investments are treated for federal income tax purposes.
1099-DIV
If you invest in a taxable account and you received any dividend income this past year, you should expect to get a form 1099-DIV from your broker. The 1099-DIV form is where your broker will report to you (the taxpayer) any dividend income you earned.
For dividend growth investors, box 1a of the 1099-DIV will report your total ordinary dividends earned for the year. Box 1b will report the amount of those dividends that were considered qualified dividends.
In order for your dividends to be considered qualified, they must meet certain criteria. The main criteria is that you must own the shares of stock that paid the dividends for at least a 60 day period.
Qualified dividends are taxed at a more favorable rate to shareholders. Since we are long term dividend growth investors, you should rarely have any dividends that are not considered qualified.
So how are dividends taxed? Take a look at the below chart:
As you can see, the rate your dividends are going to be taxed depends upon your ordinary income tax bracket. As dividend growth investors, you should be investing for the long term. Because you are investing for the long term, most of your dividend income should be qualified income and taxed at the more favorable rate.
As you can see, if you are in the lower 2 tax brackets, your qualified dividend income is taxed at a rate of 0%. This means you will pay no taxes on your dividend income.
If you are taxed in the 25% to 35% brackets, your qualified dividend income will only be taxed at the 15% tax rate which is still very favorable compared to other types of income.
Last, if you are taxed at the highest tax bracket, your qualified dividend income will be taxed at a still favorable rate of only 20%.
As you can see, qualified dividend income is taxed to the shareholder at a fairly favorable rate. For example, if instead of dividend income, you were earning interest income, your interest income would be taxed at your full ordinary income tax rate which is quite a bit higher than the rate for qualified dividend income.
This is one benefit of investing in dividend growth stocks and receiving qualified dividend income. It is taxed at a more beneficial rate to the investor compared to other types of income which will have the effect over the long term of allowing you to save and invest even more in dividend growth companies.
1099-B
The other type of tax form you may receive from your broker is the 1099-B.
If you sold any of your stocks this year, you will receive a 1099-B.
The 1099-B will report to you the proceeds you received from the sale of your stocks. If they have the cost basis, this should be reported as well as long as any short or long term capital gains/losses that were generated on the sale.
As a dividend growth investor, from time to time you may find that one of your companies isn’t meeting your expectations in some way. Therefore, you may decide it is time to sell that company and move on to a different investment.
Since dividend growth investors should strive to be long term investors, most of your gains or losses should be long term. Occasionally, you might need to sell something before owning it a full year and those gains/losses will be considered short term.
So how are your capital gains from selling stocks taxed? Let’s take a look at the chart to find out:
As you can see, it is more favorable to hold your stocks at least a year so that you qualify to only pay the long term capital gains tax rate when you sell. Of course, sometimes this is not always feasible.
The good thing for dividend growth investors, is once again we usually get to take advantage of a favorable tax rate. As long as you own your stocks for longer than a year, you pay a lower rate on your capital gains than what you pay for any other type of income (except qualified dividends).
Once again this is beneficial to dividend growth investors.
The tax laws in the United States are generally favorable to investors. This will help you over the long run build more assets by paying less in taxes.
Although we try to avoid it, there will be some times when you realize a loss on your investments. The good news is, this capital loss can usually be used to offset any capital gains you realized during the year. You should net your short term losses with short term gains. Your long term losses will be netted with long term gains. If you end up with long term gains and short term gains, they are then taxed at their respective rates. However, if you have long term gains and short term losses (or vice versa) then you can net these together and pay the taxes on whatever is left over.
Another interesting thing about capital losses is that you can deduct these losses (after netted with gains) against your ordinary income up to a certain limit. If you have more losses to take than the limit, you can carry those losses forward to be deducted in future years.
Favorable Tax Rates
As you can see, the taxes that a dividend growth investor will incur due to their investment activities are generally more favorable compared to ordinary tax rates.
This is one more reason that dividend growth investing is a great strategy.
Of course, you will only have to worry about the investing tax issues if you invest through a taxable brokerage account. If you want to avoid tax concerns, then you can invest in dividend growth stocks in an IRA or a Roth IRA. These are tax advantaged retirement accounts that will help you save money on taxes and accumulate even more assets.