Now that the first month of 2020 is almost over, it’s time to really start thinking and working on taxes. I am sure many of us are gathering tax-related documents for 2019, as well as (should be) planning for 2020 taxes. Documents that will pour in are 1098-INT, 1099-INT and… 1099-DIV for dividends received. Today’s investing topic is about bringing awareness to Dividends and Taxes!
Dividends Tax Rate
One of the immense beauties of dividend investing has to do with taxes. Yes, Dividend Investing and Taxes are a beautiful marriage that all investors should enjoy! I know what you are thinking, is there really a reason for us to love something about taxes? If true, how so?
In short, dividends are taxed at a far lower tax rate than your normal W-2 wage income. Your Dividends are taxed at the long-term capital gains tax rate (on Qualified Dividends, that is). That rate is capped at 20% on the maximum level and 0% (obviously) at the minimum level. Ordinary dividends are taxes at your ordinary income rate, however, so keep that in mind.
What exactly are those dividend tax rates? Here are the dividend tax brackets broken down below on Qualified Dividends:
If your income is in the $0-$39,700 ($0 to $78,750 for Married Filing Joint) taxable income bracket, you pay 0.00% in taxes.
Next, if your income is in the $39,701 to $434,550 ($78,751 to $488,850 for Married Filing Joint) taxable income bracket, you pay 15.00% in taxes.
Lastly, if your income is in the > $434,500 (>$488,850 for Married Filing Joint) taxable income bracket, you pay 20.00% in taxes.
How amazing is that? You can earn taxable income, if you’re single, up to $39,700 and your dividends are not even taxed! ZERO dollars, that’s it. In addition, if you are married, you can bring home almost $80,000 and you still are not taxed on qualified dividends.
Related: What is a Dividend?
Dividend Investing and Taxes
What does this mean for dividend investors? There are many strategies one can take. I will list out a few investing scenarios for you, as well as the tax implication of what that could mean.
You are a relentless investor. Your portfolio provides you $80,000 in dividends per year, because you built this powerful $2.25 million dividend portfolio. That is your ONLY income. You are married and take the basic standard deduction (BSD), which is $24,400 (for 2019). Your taxable income is $55,600. Newsflash dividend investor. Ding, ding, ding! That will be $0.00 in federal taxes.
Say you earn the average salary and have wages of $50,000 per year and you also have $35,000 in dividends coming in ($1 million portfolio), for a total of $85,000 per year. You are single. Your BSD is $12,200 (for 2019). This means you have a total of $72,800 in taxable income and fall in the 15% bracket, explained above. Your taxes you pay on dividends of $35,000 are $5,250. Therefore, your dividends tax rate is 15%.
However, what if you have wages of $60,000 per year, $15,000 in dividends but also invested $19,000 in your 401k at work, as well as put $2,500 into a Health Savings Account (HSA). Further, you put $6,000 in your traditional IRA. You are a saver, big time, and have done this for many years. Your adjusted gross income equates to $32,500 and then you also have the BSD of $12,200, bringing you down to $20,300 + $15,000 in dividends, for a total of $35,300. You will not pay any federal taxes. Thus, your dividends tax rate is 0.00%.
Related: Strategy Adjustment – Taxes, Part 3
Financial Freedom from Dividends and Taxes
Now, reading the above summarizes into one over-arching theme. You can reach financial freedom by way of dividends, due to the low-to-no tax impact on that type of income received.
As extra income on the side, dividends are taxed lower and thus you are able to get more out of each dollar you receive – whether that be to pay for your cost of living or place more funds into investment.
If dividends are your sole income – you can essentially earn $51,900 or $103,150 in dividend income if you are single or married, paying $0.00 in federal taxes.
Folks, the dividends tax rate and ability to propel your financial well being is significant.
Community – do you have any questions? What else are you doing to push income down to lower levels/brackets? Is this helpful to know or does this help push you to start dividend investing?