If I'm buying dividend fund ETFs and planning to live off on dividends with no other earned income, are the dividends distributed taxed as capital gains? If so, what is the current tax rate for singles? If not, how are dividends distributed taxed? Thank you.
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In one of your comments to the answers, you asked about state taxes on dividends/capital gains, there are states which have no capital gain tax/different tax on dividends, so editing your post to mention which state you are domiciled in may be relevant/useful.– Morrison ChangFeb 8 at 23:03
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Learn how universities and other charities invest and harvest endowments, particularly the changes in the rules from UMIFA -> UPMIFA. "Living off the dividends" used to be mandatory, and this was actually bad for the funds. That's why they changed the rules to treat dividends and capital gains as the same thing (and to eliminate "historic dollar value" but that's another conversation).– Harper - Reinstate MonicaFeb 9 at 20:36
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2 Answers
Ordinary dividends are taxed at ordinary income tax rates: 10% - 37% brackets.
Qualified dividends (most dividends issued by large-cap US companies and dividends issued by ETFs subject to holding period requirements) are taxed at capital gains rates: 0% - 20% brackets.
Current brackets for single filers are 0% for $0 - $44,625, 15% for $44,626 - $492,300, and 20% above $492,300. These are based on taxable income, so account for any deductions.
Both qualified and ordinary dividends are subject to the net investment income tax (NIIT), which adds 3.8% to investment income for incomes above $200k single / $250k MFJ. NIIT is based on modified AGI and not taxable income.
Most states don't have a separate qualified dividends/capital gains rate, but check yours to be sure.
Example: if you have $50,000 in qualified dividends in 2023 with no other income or deductions, file single and take the standard deduction ($13,850 in 2023), your taxable income is $36,150. You'll pay 0% in federal taxes.
Example: if you have $100,000 in qualified dividends in 2023 with no other income or deductions, file single and take the standard deduction, your taxable income is $86,150. You'll pay 0% on the first $44,625 and 15% from $44,626 to $86,150.
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Kind of related, I was under the impression that capital gains had two brackets based on time between acquisition and dispossession, not based on amount. For example, gains from selling a house 6 months after purchase are taxed at 30%. After 1 year or longer, gains are taxed at 15%. Is this true? If yes, then what are these other "capital gains"? Feb 9 at 16:18
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1@HelloDarkWorld not for qualified dividends - those are taxed at 0%, 15%, and 20%. If your only income is $50,000 in qualified dividends and assuming no tax deductions (aside from the standard deduction), that would push your total income low enough to fall into the 0% capital gains/qualified dividends tax rate.– Stan HFeb 9 at 22:58
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1@HelloDarkWorld Those are the marginal tax brackets for ordinary income, interest, ordinary dividends, and short-term capital gains. Here are the brackets for qualified dividends: nerdwallet.com/article/taxes/dividend-tax-rate– Stan HFeb 9 at 23:20
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Dividends are taxed as dividends, even from ETFs, but ETFs can also distribute capital gains depending on their structure. Dividends can also be qualified (lower tax rate) or unqualified depending on their source and how long you've held the ETF (you have to hold an ETF for 60 days around the ex-div date for the dividends to be qualified).
Qualified dividends are taxed at anywhere from 0% to 20% depending on your tax bracket. Unqualified dividends are taxed as regular income.
Note that dividends are cash flow but not not "income". The value of an ETF is reduced by the amount of its dividend, just like a single stock. If the stocks within the fund do not grow, the fund would shrink in value over time as it pays dividends.
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How does an ETF generate capital gains? What do you mean by "If the stocks within the fund do not grow, the fund would shrink in value over time as it pays dividends"? Feb 8 at 21:08
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2If they buy and sell stocks for some reason (less common for passive ETFs), any capital gains that occur as a result are passed on. Buy they also reduce the value, so you would have paid CG when you sold, so it just accelerates those taxes. Feb 8 at 21:19
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3@HelloDarkWorld ETFs that issue Schedule K-1 tax forms distribute income to individual investors. You're considered a limited partner in a partnership. Usually commodity ETFs, and some long-short ETFs issue K-1s. Most ETFs don't, they only issue a Form 1099-DIV, which shows interest and dividends distributed, and any capital gains/losses. For most ETFs (the ones that issue 1099s), you only realize a capital gain or loss when selling. That's different from mutual funds, which can generate gains and losses internally even if you don't sell.– Stan HFeb 8 at 21:21