Biden launches a fiery defense of his tax hikes: ‘This is about making the average multimillionaire pay just a fair share’

Biden
President Joe Biden.

  • In a Wednesday address, President Joe Biden gave an impassioned defense of his proposed tax hikes.
  • Biden wants to hike taxes on corporations and Americans making over $400,000 a year.
  • He said the rates he’s proposing have historical precedent, and he wants to offset spending.
  • See more stories on Insider’s business page.

While answering questions after a Wednesday address on the impact of the American Rescue Plan, President Joe Biden doubled down on his tax proposals and the need for wealthier Americans and corporations to pay their fair share – and took aim at prior Republican tax cuts.

“My Republican friends had no problem voting to pass a tax proposal – it expires in 2025 – that costs $2 trillion,” Biden said, adding that none of that was paid for. In fact, he said, it “gave the overwhelming percentage of those tax breaks to people who didn’t need it. The top one tenth of 1% didn’t need it.”

As for the argument Republicans gave in 2017, that it would generate a “great economic surge and growth,” Biden said “everyone from the Heritage Foundation on has pointed out it hadn’t done that.”

Then he turned to his plans to hike taxes.

“The biggest 35 or 30 corporations didn’t pay a single solitary penny last year, and they’re Fortune 500 companies,” Biden said. “They made $400 billion. They paid no taxes. How can that make any sense?”

Biden said sometime in the 2000s – he’d have his staff supply the exact date – the average CEO of a Fortune 500 company made about 36 times what the average employee of that corporation made.

“It’s over 450 times as much now. As my mother would say, who died and left them boss?” he said before raising his voice while questioning how it can benefit the economy to have CEOs make so much more than workers. “No, seriously, what rationale, tell me what benefit flows from that?”

“We’re not going to deprive” any executive “of their second or third home” or traveling privately by jet, he said.

“It’s not going to affect your standard of living at all. Not a little tiny bit,” Biden said, raising his voice, “while I can affect the standard of living of people I grew up with.”

Biden has proposed a slew of tax measures to offset the proposed spending in his two-pronged infrastructure package. Those include raising the income tax rate for the wealthiest Americans to 39.6%, bringing up the capital gains rate to the same level, and increasing the corporate tax rate from 21% to 28%. The corporate tax rate was one measure that was slashed under Trump’s tax package, falling from 35% to 21%.

Biden said he was open to compromising on the corporate tax rate – some Democrats have floated an increase to 25%, instead of 28% – but said he still wants to offset spending.

“I’m willing to compromise, but I’m not willing to not pay for what we’re talking about,” he said.

Inequality expert Sarah Anderson has testified in front of the Senate Budget Committee that the yearly gap between CEO pay and the pay of average workers is about 350 to 1.

Overall, the tax burden of Biden’s proposal would fall squarely on the top 1% of American tax filers, who would pay an average additional $100,000 per year. Biden addressed his proposal to raise the income tax rate to 39.6% for Americans making over $400,000, which he noted was a return to the Bush-era level.

“Just raise it back to what it was before. It raises enough money from that savings to put every single person in community college who wants to go,” he said. On that topic, he posed a question: “What’s going to grow America more?” The options, he said, are “the super wealthy having to pay 3.9% less tax” or an entire generation “of Americans having associate degrees.”

In closing, Biden said: “This is about making the average multimillionaire pay just a fair share. It’s not going to affect their standard of living” – pausing to whisper – “a little bit.”

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Under Biden’s plan, the top 1% of Americans would pay an extra $100,000 in taxes every year

biden amtrak
President Joe Biden and First Lady Jill Biden.

  • Biden wants to increase taxes on the highest-earning Americans to offset his spending plans.
  • His proposed increases would basically only impact the top of 1% of Americans, according to a report.
  • Biden’s tax proposals aren’t final, and his proposed capital gains increase may not go up that much.
  • See more stories on Insider’s business page.

Under President Joe Biden’s proposed tax increases, the top 1% of Americans could soon see their tax bills grow by about $100,000 per year.

A new report from the Institute on Taxation and Economic Policy (ITEP) finds that only the highest-earning Americans would see their taxes change if President Biden’s proposed increases to the income tax rate and capital gains rate pass. That change is concentrated amongst the top 1%, defined as those with an income over $681,600 (their average income is $2,167,700). The bottom 99% of taxpayers would see a 0% tax change, it said.

On average, the highest earners would see an increase of $104,130 in taxes, coming in at around 4.8% of their income. For those making between $276,200 to $681,600 – an average income of $404,100 – the average tax increase would be $20 a year.

Some states will be hit harder than others by tax increases

In a few states, a larger share of the population would feel the impact of proposed tax hikes. The report highlights that in five states – and the District of Columbia – a more than 1% share of the population would feel a hit.

Those are New Jersey, Massachusetts, Connecticut, California, and New York. In Massachusetts and New Jersey, 1.2% of the population would be affected by tax hikes. The wealthiest New York City residents will soon have the highest tax rate in the country regardless, per Insider’s Hillary Hoffower.

Biden’s proposals target the wealthy, but they’re not final

Biden’s latest tax proposals explicitly target the highest-earning Americans to offset the costs of multibillion-dollar investments in childcare, education, and paid leave. He’s also proposed raising the corporate tax rate from 21% to 28% to offset investments in infrastructure like roads and bridges.

Beyond increases, the IRS could also get about $80 billion in funding to ramp up enforcement on the wealthiest taxpayers, as Biden is proposing. A recent study by IRS researchers and academics found that the top 1% of Americans may be hiding billions from the IRS; Biden’s increased IRS funding could raise $700 billion over a decade, which would still leave the wealthy hiding hundreds of billions.

Of course, the package still has a long way to go before becoming law. A Morgan Stanley research note looked at Biden’s proposals versus what they predict as possible, and said the corporate tax rate and rate on capital gains will ultimately come in lower. However, the income tax rate increase and IRS enforcement will likely be as Biden proposes.

“Look, I’m not out to punish anyone. But I will not add to the tax burden of the middle class of this country,” Biden said in a Wednesday speech to the joint session of Congress.

He added: “When you hear someone say that they don’t want to raise taxes on the wealthiest 1% and on corporate America – ask them: whose taxes are you going to raise instead, and whose are you going to cut?”

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These 10 companies have reaped the biggest capital gains over the past year – and Biden’s tax plan could send them tumbling, Goldman says

worried trader
  • President Biden’s proposed hike in the capital gains tax rate could hurt high-flying stocks, according to Goldman Sachs.
  • “High-momentum ‘winners’ that had delivered the largest gains to investors ahead of the rate hike have usually lagged,” Goldman said.
  • The 10 stocks listed below have generated eye-popping capital gains over the past year and could suffer if Biden’s tax plan is enacted.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

A proposed capital-gains tax hike by President Joe Biden is nothing the stock market can’t handle, according to a Friday note from Goldman Sachs’ David Kostin.

But some stocks would be more susceptible to losses than others if the proposed tax hike to 39.6% for those making more than $1 million went into effect, according to the note.

“High-momentum ‘winners’ that had delivered the largest gains to investors ahead of the rate hike have usually lagged,” Kostin explained. Over the last few years, stocks within the technology and consumer discretionary sectors have been that largest source of capital gains, meaning those sectors might lag if the tax hike is approved.

These are the ten S&P 500 companies that have delivered substantial capital gains over the past year and would likely lag the broader market if Biden’s capital gains tax hike is enacted, according to Goldman Sachs.

10. Generac

Ticker: GNRC
1-Year Return: 233%

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9. Etsy

Ticker: ETSY
1-Year Return: 235%

etsyy.JPG

8. Tapestry

Ticker: TPR
1-Year Return: 237%

tapestry.JPG

7. Enphase Energy

Ticker: ENPH
1-Year Return: 321%

enphh.JPG

6. Freeport-McMoRan

Ticker: FCX
1-Year Return: 355%

fcx1.JPG

5. Gap

Ticker: GPS
1-Year Return: 368%

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4. Tesla

Ticker: TSLA
1-Year Return: 392%

tlsa.JPG

3. Caesars

Ticker: CZR
1-Year Return: 527%

czr ccc.JPG

2. L Brands

Ticker: LB
1-Year Return: 548%

lbrand.JPG

1. Penn National

Ticker: PENN
1-Year Return: 575%

pennn.JPG
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White House defends plan to hike capital gains tax, saying it’ll only hit the richest 0.3%, report says

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President Joe Biden is planning to propose a sharp increase in capital gains tax, according to reports.

  • A White House official defended plans to hike capital gains tax, according to a report.
  • President Joe Biden is set to propose the tax rises to 39.6% for the richest Americans.
  • The official told the Financial Times that it would only affect the wealthiest 0.3% in the US.

A White House official has defended plans to propose a sharp rise in the top capital gains tax rate to 39.6%, saying the changes would only hit the richest 0.3% of Americans, according to a report.

A senior official in President Joe Biden’s White House told the Financial Times the wealthiest Americans had been growing disproportionately richer.

“Many, many of the returns at the very top are what they call above-market rates of return, rents and so on,” the official said. “Taxing the people who are doing extremely well in the economy is one way of asking somewhat more from that.”

Biden is set to propose a major increase in capital gains tax from the current 20% base level this week, according to various media outlets.

Biden’s plan would propose raising the top marginal income tax to 39.6% from 37% and bringing capital gains tax in line with that for those earning more than $1 million a year.

When combined with the 3.8% surtax on investment income put in place under Barack Obama, it would take the tax rate on the wealthiest investors to 43.4%.

Republicans and many investors have criticized the plan to dramatically raise the tax, arguing that it will reduce investment and damage the economy.

However, the Biden official told the FT: “This is consistent with what the President had said on the campaign trail, which was that we needed to fundamentally reform parts of the code that affect the very, very richest or very highest income Americans, in ways to make sure that it is fair and not rewarding wealth over work.”

Yet Democrats’ razor-thin majorities in the House and the Senate mean the top rate for capital gains tax could well only end up at around 28%, according to analysts at Goldman Sachs.

“A 28% rate looks most likely, in our view, as it is roughly halfway between the current rate and Biden’s likely proposal,” the analysts said.

“This is also the rate that President Reagan and a Democratic House settled on a few decades ago when raising the tax from 20%.”

The White House has been contacted for comment.

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Dow jumps 227 points as strong economic data outweighs Biden tax-hike worry

trader Gregory Rowe
NYSE trader Gregory Rowe works on the floor of the New York Stock Exchange at the end of the trading day.

US stocks closed higher on the last trading day of the week as strong economic data outweighed investors’ fears of the capital gains tax hike proposed by President Joe Biden that would nearly double the tax rate for wealthy Americans.

All three major stock indexes rose Friday propelled by the two popular gauges of business activity that swung even higher in preliminary April readings, according to analytics firm IHS Markit.

The services activity index leaped to 63.1 from 60.4 – the fastest expansion since data collection began in 2009. The firm’s manufacturing index rose to 60.6 from 59.1, which is also a record. Markit’s composite index soared to an all-time high of 62.2 from 59.7. Readings above 50 indicate sector growth, while those below 50 signal contraction.

Ryan Detrick, chief market strategist at LPL Financial, said he was surprised by the market’s reaction to Biden’s proposal. He said investors should have expected it when Biden won.

“Calmer heads are prevailing today with the broad rally at least,” he said in a note. “On the surface, you’d think higher taxes wouldn’t be a good thing, but that’s actually not reality. In fact, the past two times we had an increase in the capital gains tax stocks did really well for the next six months in 1987 and 2013.”

Friday’s gains are a sharp rebound from Thursday’s drop when the markets were spooked after the capital gains tax hike was announced.

“The knee-jerk reaction to yesterday’s news that the Biden administration was interested in almost doubling the capital gains rate was a small selloff in the market,” Chris Zaccarelli, CIO at Independent Advisor Alliance, said in a note. “If the tax increase was actually implemented – as compared to just proposed – the selloff would have been greater.”

Zaccarelli added that the monetary and fiscal stimulus in the system should outweigh concerns over tax policy. But he also acknowledged that the market is relatively expensive by most metrics at this point, which leaves it susceptible to pullbacks, especially when unexpected news arrives.

However, analysts at Goldman Sachs said that congress is likely to settle on a much more modest increase in capital gains tax than Biden would like with the eventual figure likely to land at around 28%.

In bond markets, the 10-year Treasury note rose 1.561% from 1.554% the day prior.

“Since the end of March, we’ve seen a retrenchment of that move as the stock and bond markets have unwound some of those moves,” Zaccarelli said.

Here’s where US indexes stood at the 4:00 p.m. ET open on Friday:

Inovio Pharmaceuticals shares slipped 26% after the US government said it will discontinue funding for a late-phase trial of the company’s COVID-19 vaccine candidate.

In cryptocurrencies, bitcoin slid below $50,000 with $260 billion wiped off the crypto market as Biden’s tax proposals crushed risk appetite. Bitcoin’s weakening momentum has helped contribute to a swift 24% decline from its record high of nearly $65,000 over the past week.

“It is clear that bitcoin is more sensitive to capital gains tax threats than most asset classes,” Jeffrey Halley, a senior market analyst at OANDA, said.

“Black Swan” author Nassim Taleb also doubled down on his view that bitcoin is a Ponzi scheme and a failed currency in a CNBC interview on Friday.

“There’s no connection between inflation and bitcoin,” Taleb told CNBC, adding that everyone knows bitcoin is “a Ponzi.”

Oil prices were steady Friday as Covid-19 concerns, especially in India, rose to new highs. West Texas Intermediate crude rose 1.22% to $62.18 per barrel. Brent crude, oil’s international benchmark, was also up by 1.13% to $66.14 per barrel.

Gold slipped by 0.97% to $1,776.51 per ounce on strong economic data.

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Biden is reportedly getting even more serious about taxing the wealthy

joe biden
President Joe Biden participates in a conference phone call with governors affected by a snowstorm in the Midwest and southwest Tuesday, Feb. 16, 2021, in the Oval Office of the White House.

  • Bloomberg reports that Biden is getting more serious about some taxes targeting the rich.
  • The increases come amidst growing economic disparity throughout the pandemic.
  • Capital gains, larger corporations, and high-earners could feel the impact of the hikes under talks.
  • See more stories on Insider’s business page.

President Joe Biden is getting even more serious about raising taxes on the wealthy, according to a new Bloomberg report. It likely won’t look like a “wealth tax,” though.

Biden hasn’t said he’d enact a wealth tax like the one proposed by Sen. Elizabeth Warren, and instead he’s reportedly considering alterations to the tax code that would increase taxes on high earners without creating a brand-new tax that targets wealth.

Biden has already said that Americans making over $400,000 will see a “small to significant” tax increase. High-earning Americans could see their income taxes increase to 39%.

Now, the deputy director of the National Economic Council, David Kamin has told Bloomberg what other tax changes are currently under discussion. One is eliminating the stepped-up basis, something that Treasury Secretary Janet Yellen has already been eyeing.

That measure has to do with inheritance, and how inherited assets are valued for tax purposes. Current law lets assets that have gained value since they were originally acquired be valued at their market price and only taxed on increase from the value at the time of inheritance – not any of the prior gains.

Also under consideration, according to Bloomberg, is increasing the tax rate on capital gains, taxing them at the same rate as the income tax.

Capital gains – profits made from selling assets like stocks – are taxed differently from income once the owner has had the asset for over a year. The rates for those gains are generally lower than the income tax. Throughout his presidency, Donald Trump mostly weighed even more cuts to capital-gains tax rates. Biden’s proposal could bring the rates up to 39% for those making the most money, a far cry from rates that currently come to around 20%. Also, wealthier Americans are exactly the type of people likelier to own assets that can be sold for a capital gain.

Finally, Biden wants to raise taxes on business.

Yellen is working toward creating a global minimum corporate tax rate, under the idea that if the US can convince most other countries to set the corporate tax rate at a certain level, Biden can raise corporate taxes without fear of multinationals leaving the country.

Growing disparity has underscored the push for a tax increase

According to Bloomberg, the “administration’s intentions” have been reinforced by the K-shaped recovery taking place throughout the pandemic in which high-income Americans have seen their jobs and wages grow, while low-income Americans experience the opposite. Biden himself used the term during a 2020 presidential debate.

Throughout the pandemic, low-wage and minority workers have been hit the hardest; those low-wage jobs may also not return post-pandemic, requiring workers to learn new skills and move into different fields. On the whole, workers globally have lost $3.7 trillion in wages during the pandemic, while the world’s billionaires have added $3.9 trillion to their cumulative net worths. In the US alone, billionaires added $1.3 trillion to their net worths during the pandemic.

Biden’s $1.9 trillion stimulus did offer some relief – and increased consumer confidence – for low-income Americans. That package was passed through reconciliation, which seems to be the most likely route forward for any Democratic tax hikes.

Tax increases – and what the wealthy are (or aren’t) paying – have been a hot topic

A new report found that the top 1% of Americans are avoiding taxes more than anticipated; they’ve been failing to report about 21% of their income.

There’s also been a more targeted push by progressives to introduce a new tax on wealth. Warren introduced a new bill that would increase taxes on the top 0.05% of households. If the measure had been in place in 2020, it would have raised $114 billion from billionaires alone.

White House Press Secretary Jen Psaki has said Warren and Biden share similar objectives for addressing that “those at the top are not doing their part,” but the two ultimately have different plans.

In an interview with Bloomberg, Warren praised the American Rescue Plan and Biden’s continual advocacy for it. “There is momentum now for real change, and tax policy is a critical part of that change,” she told Bloomberg.

Warren also recently Sen. Bernie Sanders and other progressive Democrats in introducing a bill that would target corporations where CEOs are at least 50 times more than the median worker. That bill could raise up to $150 billion in 10 years.

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Investment income is taxed in a variety of ways – here’s how to estimate what you’ll owe and tips to minimize it

investment income
Your investment income may be taxed as ordinary income, at certain special rates, or not at all, depending on the type of investment it is and the sort of investment account it’s in.

  • Investment income can be taxed as ordinary income or at special rates, depending on the type it is. 
  • Capital gains and some dividends receive preferential tax rates. Interest and annuity payouts are taxed as ordinary income. 
  • All investments earn income tax-free while they remain in tax-advantaged accounts.
  • Visit Business Insider’s Investing Reference library for more stories.

You probably know that you have to pay taxes on just about all your income. But while the taxes on your work income is fairly straightforward – based on your tax bracket, and often automatically withheld from your paycheck – the tax on investment income can be more complex. 

Not all investment income is taxed equally.

In fact, your investments are taxed at different rates, depending on the type of investment you have. Some investments are tax-exempt, some are taxed at the same rates as your ordinary income, and some benefit from preferential tax rates.

When you owe the tax can also vary. Some taxes are due only when you sell the investment at a profit. Other taxes are due when your investment pays you a distribution. 

And finally, where you hold the investments matters. If the asset is in a tax-deferred account, such as an IRA, 401(k), or 529 plan, you won’t owe taxes on the earnings until you withdraw money from the account – or, depending on the type of account, ever.

See what we mean by complex? Never fear – here’s everything you need to know about the taxes on investment income, and the tax rates on different investments. 

What is investment income?

Investment income comes in four basic forms:

  • Interest income derives from the Interest earned on funds deposited in a savings or money market account, or invested in certificates of deposit, bonds or bond funds. It also applies to interest on loans you make to others.
  • Capital gains. Capital gains come from selling an investment at a profit. When you sell an investment for less than you paid for it, it creates a capital loss, which can offset capital gains.
  • Dividend income. If you own stocks, mutual funds, exchange-traded funds (ETFs), or money market funds, you may receive dividends when the board of directors of the company or fund managers decides to distribute the excess cash on hand to reward their investors.
  • Annuity payments. When you purchase an annuity, a contract with an insurance company, you pay over a lump sum. The insurance company invests your money, and converts it into a series of periodic payments. A portion of these payments can be taxable.

How is investment income taxed?

With so many variables, how can you estimate the tax bite on your investments? Here are the tax rates for different types of investment income.

Interest income

For the most part, interest income is taxed as your ordinary income tax rate – the same rate you pay on your wages or self-employment earnings. Those rates range from 10% to 37%, based on the current (2021) tax brackets. 

Some interest income is tax-exempt, though. Interest from municipal bonds is generally tax-free on your federal return; when you buy muni bonds issued by your own state, the interest is exempt from your state income tax as well.

Another exception is granted US Treasury bonds, bills, and notes, as well as US savings bonds. They are exempt from state and local taxes, though not federal taxes. 

Capital gains

The tax rate you’ll pay on capital gains depends on how long you owned the investment before selling it.

You have a short-term capital gain if you own the asset for one year (365 days) or less before selling it. Short-term capital gains are taxed at the same rate as your ordinary income.

You have a long-term capital gain if you hold on to the investment for more than one year before selling it. Long-term gains are taxed at preferential rates, ranging from 0% to 20%, depending on your total taxable income.

Capital gains are not taxable while the funds remain within a tax-advantaged IRA, 401(k), HSA, or 529 plan.

capital gains

Dividend income

The rate you pay on dividends from stock shares or stock funds depends on whether the dividend is qualified or unqualified. 

Qualified dividends are taxed at the same rates as long-term capital gains. Unqualified dividends are taxed at the same rates as ordinary income.

To count as qualified, you must have owned the dividend-producing investment for more than 60 days during the 121-day period that started 60 days before the security’s ex-dividend date. The ex-dividend date is the date after the dividend’s record date, which is the cut-off date the company uses to determine which shareholders are eligible to receive a declared dividend.

Annuity payments

The taxation of annuity payments is a little more complex. While you may earn interest, dividends, and capital gains within your annuity, you don’t owe any taxes on this income until you actually start receiving your annuity payouts. You only have tax due on the sums you receive each year.

What you owe also depends on whether you purchased the annuity with pre-tax or after-tax dollars. If you purchase an annuity with pre-tax dollars (by rolling over money from your 401(k) or IRA), payments from the annuity are fully taxable.

But if you purchase an annuity with after-tax dollars – that is, you didn’t use retirement account money, you only pay taxes on the earnings portion of your withdrawal. The rest is considered a return of principal (the original lump sum you paid into the annuity). 

 When you receive your 1099-R from your insurance company showing your annuity payouts for the year, it will indicate the total taxable amount of your annuity income.

Whether you pay tax on 100% of the annuity payments or only the earnings portion of your withdrawal, all annuity payments are taxed at the ordinary-income rate.

How do I avoid taxes on investment income?

Most investment income is taxable, but there are a few strategies for avoiding – or at least minimizing – the taxes you pay on investment returns. 

  • Stay in a low tax bracket. Single taxpayers with taxable income of $40,400 or less in 2021 qualify for a 0% tax rate on qualified dividends and capital gains. That income limit doubles for married couples filing jointly. If you can take advantage of tax deductions that will keep your taxable income below that amount, you may be able to avoid paying taxes on a significant portion of your investment income.
  • Hold on to your investments. Hanging on to stocks and other investments can help ensure you take advantage of preferential rates for qualified dividends and long-term capital gains.
  • Invest in tax-advantaged accounts. Interest, dividends, capital gains – almost all forms of investment income are shielded from annual taxes while they remain in one of these accounts. With a traditional IRA or 401(k), the money is only taxable once you withdraw funds from the account. Money earned in a Roth IRA is never taxable, as long as you meet the withdrawal requirements. Interest income from a health savings account (HSA) or 529 plan is not taxable as long as you use the money to pay for qualified medical or educational expenses, respectively.
  • Harvest tax losses. Tax loss harvesting involves selling investments that are down in order to offset gains from other investments. If you have investments in your portfolio that have poor prospects for future growth, it could be worth it to sell them at a loss in order to lower your overall capital gains. Many robo-advisors and financial advisors will take care of harvesting for you, trying to net out the winners and the losers.

The financial takeaway

A few tax-exempt assets aside, investment income is taxable. And it’s taxed in two basic ways: at ordinary income rates or at a lower preferential rate, generally known as the capital gains rate.

All assets accrue income tax-free while they remain in tax-advantaged accounts.

While it’s never a good idea to make investment decisions based solely on the tax implications, it is wise to consider the tax consequences of any investment moves you make. Taxes might not be the only reason you choose one investment over another, but tax breaks can be a bonus on any well-thought-out investment strategy.

Related Coverage in Investing:

Dividends are taxed in different ways – here’s how to figure what you owe on your stocks’ payouts

Interest income from your investments is taxable – here’s how to calculate what you owe and ways to lower it

Bitcoin taxes: Understanding the rules and how to report cryptocurrency on your return

Capital gains are the profits you make from selling your investments, and they can be taxed at lower rates

A variable annuity can provide you with more retirement income since its payouts rise with the stock market

Read the original article on Business Insider

Dividends are taxed in different ways – here’s how to figure what you owe on your stocks’ payouts

dividends2
Dividend income is taxable, but the rate varies, depending on how long you’ve owned the stock shares that pay the dividends.

  • Dividends from stocks or funds are taxable income, whether you receive them or reinvest them.
  • Qualified dividends are taxed at lower capital gains rates; unqualified dividends as ordinary income.
  • Putting dividend-paying stocks in tax-advantaged accounts can help you avoid or delay the taxes due.
  • Visit Business Insider’s Investing Reference library for more stories.

When you invest in a company by purchasing individual stocks, mutual funds, or exchange-traded funds (ETFs), you may be rewarded with dividends. A dividend is a per-share portion of the company’s profits that gets distributed regularly to its stockholders – sort of like a quarterly bonus. 

Like most other types of investment income, the IRS deems dividends to be taxable. However, not all dividends are treated – or taxed – equally. 

Here’s everything you need to know about paying taxes on dividends.

How are dividends taxed?

A variety of unearned or passive income (as opposed to income from your work or job), dividends are subject to both federal and state taxes. For tax purposes, dividends are classified as either qualified or unqualified, depending on how long you hold the underlying shares in a US corporation or a qualifying foreign corporation.

What’s the difference? Qualified dividends meet a special holding period. That means you owned the stock issuing them for at least 60 days during the 121-day period that started 60 days before the ex-dividend date. The ex-dividend date is the day after the cut-off date (aka the “record date”) the company uses to determine which shareholders are eligible to receive the dividend.

Yeah, that definition is pretty confusing. So here’s a real-life example, sort of a timeline. 

  • Say you purchased 100 shares of IBM stock on March 1, 2020.
  • On April 28, IBM’s board of directors announced a dividend of $1.63 per share to stockholders of record.
  • They set the record date as May 8, 2020. So the ex-dividend date was May 9, 2020.
  • Since you purchased the shares more than 60 days prior to the ex-dividend date (May 9, 2020), the $163 in dividends your shares earned you are qualified. On the other hand, if you’d purchased shares on April 1, you would have owned the stock for fewer than 60 days, and the dividends would be unqualified.

How much tax do you pay on dividends?

Why do dividends being qualified or unqualified matter? Because it affects the amount of tax you pay on them. 

Unqualified dividends are taxed at your ordinary income tax rate – the same rate that applies to your wages or self-employment income. So, if you fall into the 32% tax bracket, you’ll pay a 32% tax rate on all your unqualified dividends, also known as ordinary dividends.

Qualified dividends get preferential treatment. You pay the same tax rate on qualified dividends as you do on long-term capital gains. Depending on your tax bracket, this rate can be a lot lower than your ordinary income rate.

The exact rate you pay depends on your filing status and total taxable income for the year.

capital gains 06
Capital gains tax rates.

Returning to the IBM example above, let’s assume you fall into the 32% tax bracket for ordinary income and the 15% tax bracket for long-term capital gains.

If your IBM dividends are unqualified, you’ll pay roughly $52 in taxes on your $163 of dividends. But if those dividends are eligible for qualified tax treatment, you’ll pay only $24 in taxes.

How can you avoid paying taxes on dividends?

There are a few legitimate strategies for avoiding or at least minimizing the taxes you pay on dividend income.

  • Stay in a lower tax bracket. Single taxpayers with taxable income of $40,000 or less in 2020 ($40,400 or less for 2021) qualify for the 0% tax rate on qualified dividends. Those income limits are doubled for married couples filing jointly. If you can take advantage of tax deductions that reduce your income below those amounts, you can avoid paying taxes on qualified dividends, though not unqualified dividends.
  • Invest in tax-exempt accounts. Invest in stocks, mutual funds, and EFTs within a Roth IRA or Roth 401(k). Any dividends earned in these accounts are tax-free, as long as you obey the withdrawal rules.
  • Invest in educationoriented accounts. When you invest within a 529 plan or Coverdell education savings account, all dividends earned in the account are tax-free, as long as withdrawals are used for qualified education expenses.
  • Invest in tax-deferred accounts. Traditional IRAs and 401(k)s are tax-deferred, meaning you don’t pay taxes on earnings until you withdraw the money in retirement.
  • Don’t churn. Try not to sell stocks within the 60-day holding period, so any dividends will be qualified for the low capital gains rates. 
  • Invest in companies that don’t pay dividends. Young, rapidly growing companies often reinvest all profits to fuel growth rather than paying dividends to shareholders. You won’t earn any quarterly income from their stock, true. But if the firm flourishes and its stock price rises, you can sell your shares at a gain and pay long-term capital gains rates on the profits as long as you owned the stock for more than a year.

Keep in mind: You can’t avoid taxes by reinvesting your dividends. Dividends are taxable income whether they’re received into your account or invested back into the company.

The financial takeaway

Dividend stocks can be a good way to build wealth and supplement your income, so don’t let worries over taxes keep you from investing in dividend-paying stocks. 

Still, by knowing how dividends are taxed, you can do some planning to ensure you pay as little to the IRS as possible. 

Qualified dividends benefit from being taxed at lower capital gains tax rates. And you may be able to lower the tax bite even more if you keep the high-dividend-payers in tax-advantaged accounts.

Related Coverage in Investing:

What are the best college-savings investments? 5 ways to grow your money for the ever-higher costs of higher education

Dividend yield is a key way to evaluate a company and the regular payouts from its stock

Capital gains tax rates: How to calculate them and tips on how to minimize what you owe

How to invest in dividend stocks, a low-risk source of investment income

Interest income from your investments is taxable – here’s how to calculate what you owe and ways to lower it

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