April 15 is closing in fast. This is the tax filing deadline in the United States and it’s usually a painful time of the year for many people. Last year, it took me many agonizing weekends to sort out our tax return. 2014 was more complicated than usual because we sold our 4-plex and did a 1031 rollover. Also, KMP changed to KMI and this caused a huge headache because the tax instructions were very vague. Thankfully, our tax return for 2015 was much less complicated. I’m mostly done and the great thing is we don’t have to pay federal tax on our dividend income. Ahh… I love our dividend portfolio. It requires very little maintenance and our dividend income continues to increase over time regardless of how volatile the stock market is.
Dividend Income
In 2015, we had $10,445 in dividend income. That’s pretty good and I plan to increase it to $11,500 this year. The dividend income is getting more significant and it’s really nice that we don’t have to pay federal taxes on this. Let’s take a closer look at our dividend income and the tax code.
- Ordinary dividends: $10,445
- Qualified dividends: $10,068
The qualified dividends are taxed at the long term capital gain rate. This is really good because the long term capital gain rate is usually lower than the ordinary income rate. Non-qualified dividends are taxed at your ordinary income rate.
As you can see, some our dividends are non-qualified. These are dividend income from REITs, MLPs, tax-exempt corporations, and foreign corporations. In our statement, the following are non-qualified.
- NNN: $273. This is a real estate investment trust.
- OHI: $51. This is also a REIT.
- VLP: $53. This is Vanguard Pacific region ETF.
Anyway, a very small percentage of our dividend income is non-qualified. And we end up paying $43 in tax for this small portion. The vast majority of our dividend income is qualified and we didn’t have to pay any federal tax on it this year. That’s $1,500 in our pocket instead of Uncle Sam.
No tax on dividend income
Everyone who invests in the stock market should know the capital gains are taxed at a lower rate than ordinary income (wage, interest, and earned income). This is good to know because many of us should qualify for the 0% capital gain tax. Here is a 2016 tax table for a quick reference.
The important thing to note here is if you’re in the 10% and 15% tax bracket, then your long term capital gain tax rate is 0%. Isn’t that awesome?
Tax summary
Let’s take a look at the summary of our 2015 tax.
The Adjustments are due to the amount contributed to my i401k and self-employment tax. For deductions, we have mortgage interest, state and local taxes, and some donations.
Our taxable income is comfortably under the 15% tax bracket. In fact, we could increase our dividend income by $30,000 and it wouldn’t increase our federal tax payment. I double checked it in the (affiliate link.) This is why I like doing my own tax. I can plug in different numbers to see how the modifications affect our tax return. It’s great to know we have a lot of headroom for long term capital gain. This knowledge is useful because I will be able to reset the basis on some of my stock investment this year. I can sell some stocks and buy it right back at the same price. Here is an example.
- I purchased 100 shares of XYZ for $10 each in 2014. Cost basis = $1,000.
- I sell 100 shares of XYZ for $20 each in 2016. Long term capital gain is $1,000, but I don’t have to pay any tax.
- I buy back 100 shares of XYZ right away for $20 each. Now my new cost basis is $2,000.
Why do this? If our income increases in the future and pushes us above the 15% tax bracket, then we will have to pay tax on long term capital gain. Gain is sale price minus the cost basis. By resetting the cost basis, we lower the capital gain and we’ll pay less tax. Also, the long term capital gain tax rate may increase in the future.
How to pay no tax on your dividend income
Actually, it is not a bad thing if you’re paying tax on your dividend income. That means your earned income is quite high. Anyway, here is how to pay no taxes on your long term capital gain. You need to push your taxable income into the 15% tax bracket.
- Maximize your deduction and adjustments. Everyone should max out their 401k contribution every year.
- Do your own taxes so you understand the tax code better. Or at least get a good briefing from your tax guy about how to reduce your tax.
- Reduce your taxable income. Rental properties are a great way to do this because you can take depreciation and offset some of your other income. HSA and childcare expenses are also great ways to offset your income.
- Live in a state with no income tax. Don’t forget about state tax. We still have to pay 9% tax on our dividend income to Oregon.
- If all else fail, you can always retire early and reduce your income that way. 😉
Okay, I think that’s enough about taxes. I hope I didn’t put too many people to sleep. I know our editor (Mrs. RB40) will barely be able to stay awake though this post.
Did you finish your 2015 tax return? Do you have to pay tax on your dividend income?
Image credit:by jasoneppink
Disclosure: There is an affiliate link in this article. I may get a referral fee if you sign up or purchase the H&R Block tax software linked above.
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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
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FAQs
You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.
How do I live off dividends without paying taxes? ›
You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.
How do I not get taxed on dividends? ›
Your “qualified” dividends may be taxed at 0% if your taxable income falls below $44,625 (if single or Married Filing Separately), $59,750 (if Head of Household), or $89,250 (if (Married Filing Jointly or qualifying widow/widower) (tax year 2023).
Are dividends tax-free in retirement? ›
A common exception is dividends paid on stocks held in a retirement account such as a Roth IRA, traditional IRA, or 401(k). These dividends are not taxed since most income or realized capital gains earned by these types of accounts is tax-deferred or tax-free.
How do I pay zero taxes in retirement? ›
Maximize your tax benefits with Roth IRA distributions, as withdrawals from a Roth IRA during retirement are totally tax-free. Prepare for required minimum distributions in 2023 and diversify your retirement income sources to keep your overall tax bill low.
Can you retire and live off dividends? ›
A Dividend Portfolio Preserves Your Retirement Savings:
Ideally, the portfolio can be created in such a way that you can live off a dividend stream of payments without withdrawing from your principal balance. The strategy helps you avoid dipping into your savings thus helping your retirement funds last longer.
How much do you need to retire and live off dividends? ›
How Much Money You Need to Retire on Dividends. As a rough rule of thumb, you can multiply the annual dividend income you wish to generate by 22 and by 28 to establish a reasonable range for how much you need to invest to live off dividends.
How much tax will I pay on my dividend income? ›
How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.
Do dividends count as income for social security? ›
Pension payments, annuities, and the interest or dividends from your savings and investments are not earnings for Social Security purposes. You may need to pay income tax, but you do not pay Social Security taxes.
Do I have to file a tax return if my only income is dividends? ›
If you had over $1,500 of ordinary dividends or you received ordinary dividends in your name that actually belong to someone else, you must file Schedule B (Form 1040), Interest and Ordinary Dividends. Please refer to the Instructions for Form 1040-NR for specific reporting information when filing Form 1040-NR.
Earning dividends is a great incentive for investing in certain companies and mutual funds. Dividends are particularly useful for people who want to supplement their retirement income. However, like all income, you'll need to pay taxes on any dividends you receive.
What is the dividend rule for retirement? ›
The 4% rule is intended to supply a steady stream of income while maintaining an adequate account balance for future years. Assuming a reasonable rate of return on investment, the withdrawals will consist primarily of interest and dividends. Experts disagree on whether the 4% rule is the best option.
What income is tax-free in retirement? ›
Municipal bonds are another potential source of tax-free retirement income. Interest income earned from municipal bonds is generally free of federal, and sometimes also state and local, income taxes.
At what age is Social Security no longer taxed? ›
Social Security income can be taxable no matter how old you are. It all depends on whether your total combined income exceeds a certain level set for your filing status. You may have heard that Social Security income is not taxed after age 70; this is false.
What is the best tax strategy for retirement? ›
Most retirees rely on a few different sources of income, and there are ways to minimize taxes on each of them. One of the best strategies is to live in or move to a tax-friendly state. Other strategies include reallocating investments, so they are tax-efficient and postponing distributions from retirement accounts.
Do you pay taxes on dividends that are reinvested? ›
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.
How much money do you need to make $50,000 a year off dividends? ›
This broader mix of stocks offers higher payouts and greater diversification than what you'll get with the Invesco QQQ Trust. And if you've got a large portfolio totaling more than $1.1 million, your dividend income could come in around $50,000 per year.
How to make $5000 a month in dividends? ›
To generate $5,000 per month in dividends, you would need a portfolio value of approximately $1 million invested in stocks with an average dividend yield of 5%. For example, Johnson & Johnson stock currently yields 2.7% annually. $1 million invested would generate about $27,000 per year or $2,250 per month.
Can you live off dividends of 1 million dollars? ›
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
April 15 is closing in fast. This is the tax filing deadline in the United States and it’s usually a painful time of the year for many people. Last year, it took me many agonizing weekends to sort out our tax return. 2014 was more complicated than usual because we sold our 4-plex and did a 1031 rollover. Also, KMP changed to KMI and this caused a huge headache because the tax instructions were very vague. Thankfully, our tax return for 2015 was much less complicated. I’m mostly done and the great thing is we don’t have to pay federal tax on our dividend income. Ahh… I love our dividend portfolio. It requires very little maintenance and our dividend income continues to increase over time regardless of how volatile the stock market is.
