This is one of the best parts of dividend income.
How to do it
Firstly, there are qualified and non-qualified dividends. Non-qualified dividends come from REITs, MLPs, tax-exempt corporations, and foreign corporations. Qualified dividends mostly come from United States corporations and are subject to the same tax rates as long-term capital gains. Long-term capital gains are defined as a gain from a qualifying investment owned for longer than 12 months. If you’re in the 15% tax bracket (or below) you pay 0% tax on your long term capital gains. The 15% tax bracket for 2016 if you’re filing single is up to $37,650. If you’re married and filing jointly it is up to $75,300.
Use this to your advantage
So if you’re single and you’ve owned all your qualifying dividend stocks for over a year and they total less than $37,650 in income you’ll pay $0.00 in taxes! Another way this can be used to your advantage is if you’re approaching your $37,650 limit. For example, you bought 100 shares of Company 1 in 2012 for $20 a share. Totaling $2,000, this is your cost basis. Now in 2016 you’re approaching your $37,650 limit. Company 1 now trades for $30 per share. You sell your shares of Company 1 for a profit of $1,000 that you won’t have to pay tax on. Now you repurchase another 100 shares of Company 1 at $30.
What’s the point of this? The point is you’ve just reset your cost basis. So what? Gain is calculated by sale price minus the cost basis. Now you’ve significantly reduced your gain on Company 1 and thus giving yourself more room to increase gains and stay in the 15% tax bracket.
How much tax do you pay on your dividends every year?