Loading the player...
A:

The U.S. tax code gives similar treatment to dividends and capital gains, although this will change slightly in 2013.

Currently, ordinary dividends and short-term capital gains those on assets held less than a year are subject to one's income tax rate. However, "qualified dividends" and long-term capital gains benefit from a lower rate. Qualified dividends are those paid by domestic or qualifying foreign companies that have been held for at least 61 days out of the 121-day period beginning 60 days prior to the ex-dividend date.

In the case of qualified dividends and long-term capital gains, individuals in the 25% or higher tax bracket currently pay a 15% tax, whereas those in lower brackets are exempt from any tax. Beginning in 2013, the long-term capital gains rate will jump to 10% for lower income earners and 20% for investors in the higher brackets.

Meanwhile, the preferential treatment given to qualified dividends is set to disappear completely. As of 2013, individuals will have to pay their income tax rate on all dividend income they receive.

In Canada, tax treatment is a little simpler because there's no parsing of capital gains and dividends into different categories. In the case of capital gains, residents pay their marginal tax rate, but only on half the amount. Under certain conditions, selling one's primary residence is exempt from taxation altogether.

Dividends also get preferential treatment in Canada, although it may not seem that way on the surface. Investors have to pay their marginal income tax rate, and 125% of the dividends are taxable. However, national and provincial credits (the federal dividend tax credit alone is 13.33% of the taxable amount) help offset one's liability. Consequently, the actual tax can end up being significantly lower than one's income tax rate.

Here's an example. Let's assume you're in the 25% tax bracket and received $10,000 in dividends for the year. Your earnings are "grossed up" to $12,500, so your initial tax liability is $3,125. But if you assume a 5% provincial tax credit, that amount is reduced by $625 ($12,500 x 0.05 = $625) and by an additional $ ($12,500 x 0.1333 = $1,666.25) at the federal level. In the end, your tax liability is only $833.75, or 8.3% of your actual dividend income.

RELATED FAQS
  1. If I reinvest my dividends, are they still taxable?

    Take a brief look at how the Internal Revenue Service taxes different kinds of dividends, including taxation on dividends ... Read Answer >>
  2. Are dividends considered passive or ordinary income?

    Find out why dividends are not considered passive income and why some dividends are subject to a reduced tax rate based on ... Read Answer >>
  3. When does the holding period on a stock dividend start?

    Understand the difference between qualified and unqualified stock dividends, and when the holding period for qualified dividends ... Read Answer >>
  4. Are capital gains taxed differently in different countries?

    Learn about capital gains taxes in the Unites States as well as those of other countries, where these tax rates vary significantly. Read Answer >>
  5. How can I find out which income tax bracket I am in?

    Find out how to determine your federal income tax bracket and calculate how much you will owe in federal taxes with online ... Read Answer >>
  6. How does the marginal tax rate system work?

    The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. As the marginal tax ... Read Answer >>
Related Articles
  1. Taxes

    How Are Capital Gains And Dividends Taxed Differently?

    Individuals in the 25% or higher tax bracket pay a 20% tax on long-term capital gains.
  2. Investing Basics

    Understanding How Dividends Are Taxed

    Learn how dividends are taxed by the IRS, and understand the different types of dividend income as well as the capital gains tax rates.
  3. Taxes

    Comparing Long-Term vs. Short-Term Capital Gain Tax Rates

    Learn about the difference between short- and long-term capital gains and how the duration of your investment can impact your tax liability.
  4. Investing Basics

    3 Tax Implications of Dividend Stocks

    Dividend paying companies are attractive in a low interest rate environment, but income seeking investors have to be careful of the potential tax hit.
  5. Mutual Funds & ETFs

    Understanding Taxes on Mutual Funds Dividends

    Learn about the basics of mutual fund dividend taxation, including how and why mutual funds pay dividends and when different tax rates apply to dividend income.
  6. Personal Finance

    3 Ways To Avoid The Dividend Tax Hike

    Find out how you can offset the potential tax hikes.
  7. Investing Basics

    Investment Tax Basics For All Investors

    Nothing can be said to be certain, except death and taxes even in your investments.
  8. Retirement

    Dividends Still Look Good After All These Years

    Find out how this "first love" still holds its bloom as it ages.
  9. Mutual Funds & ETFs

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  10. Mutual Funds & ETFs

    How to Find Mutual Funds With High Dividends

    Learn about the important factors to consider when looking for mutual funds that pay high dividends, including how they may impact your taxes.
RELATED TERMS
  1. Qualified Dividend

    A type of dividend to which capital gains tax rates are applied. ...
  2. Dividend Tax Credit

    The amount a Canadian resident applies against their tax owing ...
  3. Marginal Tax Rate

    The amount of tax paid on an additional dollar of income. The ...
  4. Effective Tax Rate

    The average rate at which an individual or corporation is taxed. ...
  5. Dividend

    A distribution of a portion of a company's earnings, decided ...
  6. Tax Rate

    The percentage at which an individual or corporation is taxed. ...
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center