I've been considering selling off more of my (growth) stocks and placing the capital in dividend stocks. However, I realize Uncle Sam will tax me on any dividends I earn throughout the year. Is holding these stocks in a tax free account, such as an an IRA, the only way to avoid taxes? Will having the dividends automatically re-invested (like DRIP from TD Ameritrade) still trigger taxes? I dont want to hold the stocks longterm (~ 2- 3 years), as I already have a mutual fund.
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2Dividend re-investment does not avoid taxation of the dividends. Do you know about Qualified Dividends that are taxed at the (lower) long-term capital gains tax rate instead of as ordinary income?– Dilip SarwateApr 1, 2014 at 14:10
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A contradiction in terms.– user11865Apr 1, 2014 at 21:42
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I'm not sure what you're referring to, quanty.– derelictApr 2, 2014 at 13:24
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Qualified dividends are not very hard to achieve. Most small investors getting 1099-DIVs from a broker will have only qualified dividends (reported on box 1b). Pub 17, ch 8 and the 1099-DIV instructions have the details. But note that in technical tax terms, even qualified dividends are still considered "ordinary income," though they are taxed at CG rates.– NL7Apr 2, 2014 at 14:27
1 Answer
Having dividends automatically reinvested (i.e. DRIPs) will cause a tax liability for the value of the dividends.
Qualified dividends (i.e. specific holding period requirements) are currently taxed at a rate lower than ordinary income tax.
Yes, for normal people the way to avoid/defer paying taxes is by using a retirement account (e.g. Roth IRA/IRA/401k). There are of course plenty of legal constructs to manipulate the tax implications of any transaction.