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I own stocks and ETFs in my taxable brokerage account at Vanguard, and these securities generate taxable dividend income every year, which is a problem. How do I fix it?

It was a bad idea on my part: instead of ETFs, I should have bought mutual funds. Also, it's better to keep dividend-paying stocks in a Roth IRA account.

Now I'm trying to fix this problem. Here's a list of options that I've considered:

  • Convert Vanguard ETFs to Vanguard mutual funds. This is not possible without selling the ETFs, which is a taxable event.
  • Transfer stocks to my Roth IRA. This is also not possible, as far as I know.
  • Take a year off. If my wages were low enough, I could convert about 40k of capital gains tax-free, but this is not an option for me right now.
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    Dividends from mutual funds are taxable too (even if they reinvest them for you) - or are there equivalent vanguard funds that reinvest dividends within the fund?
    – D Stanley
    Dec 13, 2021 at 23:07
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    I find it odd that you are willing to not work for a year to avoid paying capital gains taxes on 40k gains (which is about 6k) when the loss of not working is much greater. Why are you so eager to avoid taxes?
    – rtaft
    Dec 14, 2021 at 13:54
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    Having to pay more taxes because you had more actual income is not a bad thing. Dec 14, 2021 at 14:54
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    @DStanley Even if they reinvest internally, they're still required to distribute dividends to shareholders.
    – Barmar
    Dec 14, 2021 at 16:01
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    Do you know about qualified dividends? They have 0% tax up to 40+k$.
    – Aganju
    Dec 14, 2021 at 20:34

4 Answers 4

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Convert Vanguard ETFs to Vanguard mutual funds. This is not possible without selling the ETFs, which is a taxable event.

True, but dividends from mutual funds are taxable too (even if they reinvest them for you). So this would only be beneficial if there are equivalent vanguard funds (or ETFs) that reinvest dividends within the fund. Or if you find ETFs with a lower dividend yield. Also remember that dividends do not produce return since they reduce the value of the fund by the same amount. They just produce cash flow and possible incur tax now in exchange for less tax later.

Transfer stocks to my Roth IRA. This is also not possible, as far as I know.

Correct - you can only contribute cash to IRAs, so you'd still need to sell the ETFs and incur capital gains tax.

Take a year off. If my wages were low enough, I could convert about 40k of capital gains tax-free, but this is not an option for me right now.

It seems stupid at face value to forego a year's worth of income to save on capital gains tax.

Some other options:

  • Increase your retirement contributions. The tax deduction would offset the taxable dividend income. You're effectively taking the dividend income and putting in in an IRA.

  • Bite the bullet and pay the tax. Dividends reduce the value of funds (and ETFs) proportionally, so the "bright side" is that you'll pay less tax when you do sell the ETFs.

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@D Stanley addressed your specific questions.

I'd add that you can deduct $3k in losses each year so you may be able to offset some of your dividend income by selling off some ETF shares. This assumes that you haven't already incurred $3k of realized losses.

Designate your highest cost basis purchases and sell enough to offset up to $3k of dividend income, maximizing your repatriated capital.

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    I believe the $3k limit is for Net capital losses, meaning you are reporting a negative number on schedule D. A net loss of over $3k can be carried forward to future years.
    – Andy C
    Dec 14, 2021 at 14:59
  • There is no limit for Tax loss harvesting and it's the best way to offset those gains....but personally I would rather pay the taxes than lose money on other investments.
    – rtaft
    Dec 14, 2021 at 17:09
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    There is no limit on offsetting capital gains with capital losses but you cannot offset > $3k of dividend income with > $3k of net capital losses. Dec 14, 2021 at 17:18
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It's too late to affect the taxes you owe this year on dividends in your taxable account, but in the future you might want to concentrate on mutual funds and ETFs that pay most of their dividends as qualified dividends. Ordinary dividends are taxed just like wages or interest income, as you have discovered. Qualified dividends are taxed at the more favorable capital gains tax rates, which ranges from 0% to 20% but it's 15% for most investors.

You won't know the exact mix of ordinary and qualified dividends until you see your 1099-DIV, because qualified dividend eligibility depends on how the mutual fund or ETF manager trades stocks during the year. You can look at past years' results to get a good idea though.

I hold about a dozen index mutual funds and ETFs in a 60/40 domestic and international mix, and I get about 80% of dividends each year as qualified dividends. This greatly reduces tax liability.

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  • For many ETFs it is possible to find out composition of the distribution around the time of announcement. Many stock research/screening tools allow that (one provided by Fidelity for instance). Some brokers show composition in transaction history (TDA, Schwab). Dec 14, 2021 at 22:23
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In addition to previous posts. If your keep mainly dividend-paying stock/ETFs in taxable brokerage account, it's better to be sure that it's a "cash" account (not a "margin" one). There is a good chance that the broker will lend your shares kept in margin account to someone who short-sells them. In this case, while your shares are lent-out, you will receive "cash in lieu of dividends" in the same amount as your shares pay dividends. And these payments are taxed as "ordinary income", at potentially higher tax rate that dividends. That's not going to happen in "cash" account that does not allow margin trades, short sales, borrowing of shares.

Another point. Not all distributions an ETF pays are dividends (depending on the ETF). There might be short/long-term capital gains, returns of capital, qualified/ordinary dividends. All taxed differently, some will affect your capital gain calculations and could be offset by capital losses from previous years.

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