Are Reinvested Dividends Taxable?
Yes, dividend payments are taxable. But depending on how you set things up, you may be taxed at a rate of Capital Gains of 0% or at your Income Tax Rate. When using a Dividend Reinvestment Plan, you can defer that payment for many years.
1. What Is A Dividend Payment on Stocks
A dividend is an offer from the company, confirmed by the board of directors, to pay out a portion of its income (after-tax profits) to its shareholders. These companies tend to be well established with a stable income stream, enabling them to offer a constant & consistent dividend.
The dividend is mainly a reward to the shareholder for holding the stock.
2. Dividend Payment Types
You can receive a dividend in two very different ways, via a cash dividend payout, or with a dividend reinvestment plan.
Cash Dividend Payout – Income
Typically this type of payment is a cash payment to the holder of the company’s shares paying the dividend.
Reinvested Dividend – Dividend Reinvestment Plan (DRIP)
Instead of receiving a quarterly dividend payment from the company, you can elect to have the dividend reinvested into a DRIP. This means that the dividend payment you would receive will be used to buy more shares in that company.
3. Dividend Reinvestment Plan Tax Treatment
A dividend payment is an income, therefore taxable, but the rate of tax you pay on a dividend payment can be controlled by your behavior when purchasing a stock.
The Ordinary Dividend is subject to income tax, so depending on your income tax rate when the payment is due, you will pay at that rate.
Qualified Dividends are typically either Regular Cash Dividends or Extra Dividends that “Qualify” for different Tax Treatment in the U.S.A. As an investor, if you hold the stock long enough and have stock in the right type of company, the lower Long-Term Capital Gains Tax is applied, which is typically significantly lower. See Ordinary vs. Qualified Dividends – Lower Tax Higher Profit
Ultimately dividend payments are taxable, but depending on how you set things up, you may be taxed at a rate of Capital Gains of 0% or at your Income Tax Rate. But, using a Dividend Reinvestment Plan, you can defer that payment for many years.
4. How is Taxation on Cash Dividends and Reinvested Dividends Different
The difference between the taxations of payments on Cash Dividend Payments and Reinvested Dividends is the word “Realized Gains.”
If you received a cash dividend payment every quarter, this is a realized income. Therefore you will be taxed on it either as a Regular or Qualified Dividend, and the tax will be due shortly after the company’s Dividend Declaration Date.
If you have established your Dividend Reinvestment Plan, then you receive the payment in the form of extra shares into your DRIP account. They then remain un-realized and are therefore not taxed until the stock is sold.
If you hold the stock for many years, you will substantially delay the taxation and accrue profits on the untaxed stock, a good option for long-term investors. There are significant advantages for the company and shareholders in Dividend Reinvestment Plans.