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. Is there a difference between capital gains and dividend income?

    Selling something for a profits leads to capital gains. A payment made by a corporations to stockholders is a dividend. Both ... Read Answer >>
  2. In what situations must taxes be paid on a stock dividend?

    Understand the situations in which investors must pay taxes on stock dividends received, and the different tax rates that ... Read Answer >>
  3. 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 >>
  4. Are qualified dividends included in gross income?

    Qualified dividends receive different tax treatment than ordinary income. This is important since planning can be done to ... 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. Taxes

    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. Financial Advisor

    How to Plan for Taxes on Dividends

    Dividends are taxed differently than other investment income. Here are some strategies to help lower taxes on dividends.
  5. Taxes

    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.
  6. Investing

    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.
  7. Investing

    Dividends Still Look Good After All These Years

    Find out how this "first love" still holds its bloom as it ages.
  8. Investing

    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.
  9. Taxes

    Investment Tax Basics For All Investors

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

    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. Capital Gains Treatment

    The specific taxes assessed on investment capital gains as determined ...
  4. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  5. Effective Tax Rate

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

    A distribution of a portion of a company's earnings, decided ...
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center