Tax Implications of Stock Dividends

Investing in dividend stocks is one method of investment that should be considered when building a portfolio. Buying stocks that issue a dividend can present you with several advantages as an investor. However, there are some tax implications that you will have to consider before investing.

Dividend Taxation

A dividend is a payment that is made from a corporation's profits to the shareholders of that corporation. Many corporations issue these payments as a way to share the wealth with the investors in the company. Many investors choose to buy stocks of corporations that regularly pay dividends because this presents them with a regular payment.

Calculating the taxes on dividends is quite simple. Dividends are considered a source of ordinary income in this country. Therefore, they are taxed at your marginal tax rate. The tax rate depends on how much you make overall for the year.

Many investors are confused because the capital gains tax rate is less than what you will pay for your personal tax rate in most cases. Therefore, when you actually sell a stock for a gain, you pay one tax rate, and when you get a dividend from a stock, you pay another. It can be a little confusing, and it would probably be to your advantage to have a tax professional help you when it comes time to file.

Double Taxation

One issue with dividend taxes is double taxation. Many investors have a major problem with how dividends are taxed, and this topic tends to raise some heated debates. The issue with this is that the corporations initially pay taxes on the money as part of their profit for the year. Then they issue the rest of the money out to the shareholders as a dividend. After the shareholders receive the dividend, they, in turn, have to pay taxes on the money. It is the threat of double taxation that causes many wealthy people to put their money elsewhere.

Reinvesting Dividends

Something else that you may want to consider about taxes concerns reinvesting your dividend into stock. Many people use this strategy as a way to rapidly build their portfolios. While it does have some nice potential to help you, it can cause an issue with the taxes.

The idea behind this method is simple. You take the dividends that you are paid from your stocks and use that money to buy more stocks. Then the next time a dividend is issued, it will actually be larger because you have more shares of the stock. As a result of that, you can then buy more shares of stock the second time. You keep taking the dividend payments and buying more shares every time.

The issue with this method is that you still have to pay taxes on the payments that you received. Therefore, you will have to use some other income source to pay the taxes.

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