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How to Pay No Tax on Your Dividend Income


Pay No Tax on Your Dividend IncomeApril 15 is closing in fast. This is the tax filing deadline in the United States and it’s usually a painful time of the year for many people. Last year, it took me many agonizing weekends to sort out our tax return. 2014 was more complicated than usual because we sold our 4-plex and did a 1031 rollover. Also, KMP changed to KMI and this caused a huge headache because the tax instructions were very vague. Thankfully, our tax return for 2015 was much less complicated. I’m mostly done and the great thing is we don’t have to pay federal tax on our dividend income. Ahh… I love our dividend portfolio. It requires very little maintenance and our dividend income continues to increase over time regardless of how volatile the stock market is.

Dividend Income

In 2015, we had $10,445 in dividend income. That’s pretty good and I plan to increase it to $11,500 this year. The dividend income is getting more significant and it’s really nice that we don’t have to pay federal taxes on this. Let’s take a closer look at our dividend income and the tax code.

  • Ordinary dividends: $10,445
  • Qualified dividends: $10,068

The qualified dividends are taxed at the long term capital gain rate. This is really good because the long term capital gain rate is usually lower than the ordinary income rate. Non-qualified dividends are taxed at your ordinary income rate.

As you can see, some our dividends are non-qualified. These are dividend income from REITs, MLPs, tax-exempt corporations, and foreign corporations. In our statement, the following are non-qualified.

  • NNN: $273. This is a real estate investment trust.
  • OHI: $51. This is also a REIT.
  • VLP: $53. This is Vanguard Pacific region ETF.

Anyway, a very small percentage of our dividend income is non-qualified.  And we end up paying $43 in tax for this small portion. The vast majority of our dividend income is qualified and we didn’t have to pay any federal tax on it this year. That’s $1,500 in our pocket instead of Uncle Sam.

No tax on dividend income

Everyone who invests in the stock market should know the capital gains are taxed at a lower rate than ordinary income (wage, interest, and earned income). This is good to know because many of us should qualify for the 0% capital gain tax. Here is a 2016 tax table for a quick reference.

Pay $0 tax on dividend income

The important thing to note here is if you’re in the 10% and 15% tax bracket, then your long term capital gain tax rate is 0%. Isn’t that awesome?

Tax summary

Let’s take a look at the summary of our 2015 tax.

pay no tax on dividend income

The Adjustments are due to the amount contributed to my i401k and self-employment tax. For deductions, we have mortgage interest, state and local taxes, and some donations.

Our taxable income is comfortably under the 15% tax bracket. In fact, we could increase our dividend income by $30,000 and it wouldn’t increase our federal tax payment. I double checked it in the H&R Block tax software (affiliate link.) This is why I like doing my own tax. I can plug in different numbers to see how the modifications affect our tax return. It’s great to know we have a lot of headroom for long term capital gain. This knowledge is useful because I will be able to reset the basis on some of my stock investment this year. I can sell some stocks and buy it right back at the same price. Here is an example.

  • I purchased 100 shares of XYZ for $10 each in 2014. Cost basis = $1,000.
  • I sell 100 shares of XYZ for $20 each in 2016. Long term capital gain is $1,000, but I don’t have to pay any tax.
  • I buy back 100 shares of XYZ right away for $20 each. Now my new cost basis is $2,000.

Why do this? If our income increases in the future and pushes us above the 15% tax bracket, then we will have to pay tax on long term capital gain. Gain is sale price minus the cost basis. By resetting the cost basis, we lower the capital gain and we’ll pay less tax. Also, the long term capital gain tax rate may increase in the future.

How to pay no tax on your dividend income

Actually, it is not a bad thing if you’re paying tax on your dividend income. That means your earned income is quite high. Anyway, here is how to pay no taxes on your long term capital gain. You need to push your taxable income into the 15% tax bracket.

  • Maximize your deduction and adjustments. Everyone should max out their 401k contribution every year.
  • Do your own taxes so you understand the tax code better. Or at least get a good briefing from your tax guy about how to reduce your tax.
  • Reduce your taxable income. Rental properties are a great way to do this because you can take depreciation and offset some of your other income. HSA and childcare expenses are also great ways to offset your income.
  • Live in a state with no income tax. Don’t forget about state tax. We still have to pay 9% tax on our dividend income to Oregon.
  • If all else fail, you can always retire early and reduce your income that way. 😉

Okay, I think that’s enough about taxes. I hope I didn’t put too many people to sleep. I know our editor (Mrs. RB40) will barely be able to stay awake though this post.

Did you finish your 2015 tax return? Do you have to pay tax on your dividend income?

Image credit: by jasoneppink

Disclosure: There is an affiliate link in this article. I may get a referral fee if you sign up or purchase the H&R Block tax software linked above.

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, he couldn't stomach the corporate BS.

Joe left his engineering career behind to become a stay-at-home dad/blogger at 38. Today, he blogs about financial independence, early retirement, investing, and living a frugal lifestyle. See how he generates Passive Income here.

Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.

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{ 54 comments… add one }
  • Sam @ Financial Samurai March 14, 2016, 12:40 am

    I’m very envious that you don’t have to pay long-term capital gains tax on your dividend income. What is the income phaseout? Because it can be as soon as you hit one dollar over the 15% tax bracket you lose everything.

    I guess another scenario is this: would you rather make $100,000 after all deductions and contributions and pay long-term capital gains tax? Or make what you make and not?


    • retirebyforty March 14, 2016, 10:36 am

      From what I understand, the phase out for married couple is $75,300. That’s pretty high considering all the deductions and adjustments available.
      I prefer to make more money and pay the 15% long term capital gain tax. I’m pretty sure, most people would choose the same. 🙂

      • Sam @ Financial Samurai March 14, 2016, 2:42 pm

        Any idea how the phaseout phases out though? It can’t be once you make $1 over $73,500, you go from 0% tax rate to 15%. There has to be another income that once you get there, like $95,000 or something, then you have to pay 15% tax. Otherwise, the path wouldn’t work.

        • Noah @ Money Metagame March 14, 2016, 5:35 pm

          I’m pretty sure the dividend tax rate (or any long-term gains) works just like regular taxes in that they break the amounts into buckets that are taxed at different (the marginal) rates.

          For example, a married couple that had $50k in earned income and $50k in dividend income would be taxed accordingly. We’ll ignore deductions and such.:
          $0-50,000: Taxed regularly at 10/15% because it’s earned income
          $50,001-75,300: Taxed at long-term gains rate within 15% bracket = 0% = $0 in taxes
          $75,301-$100,000: Taxes at long-term gains rate within 25% bracket = 15% = $3705 in taxes

          Basically they stack in the long-term gains/dividends on the end of your income and then just use the long term gain rate instead of the regular tax rate. There’s no cliff where you’d end up having less take-home by making more money.

          • retirebyforty March 15, 2016, 10:34 am

            It looks like Noah is correct. You only pay 15% on the amount over $75,300, the 15% bracket. At that point it starts to get tricky because you also lose some credits and write off because you make a bit too much money. I did a little experiment in H&R block. We will pay about the same amount of tax up to around $40,000 in dividend income. Jumping from $40k to $50k in dividend income increased our tax by $2,500. It seems the point that we cross over the 15% tax bracket is also the point that we lose some deductions, in our case.

  • Lorraine March 14, 2016, 4:09 am

    This is our first year of early retirement (financial freedom!) and can’t believe what a difference staying in the 15% tax bracket makes! We are looking to increase our dividend income to take full advantage of this gift.

    The best part is after probably 20 years, we are actually getting a refund…unbelievable.

    • retirebyforty March 14, 2016, 10:37 am

      Congratulation! It’s great to get a refund. We’ll have to send a little check to the IRS, but we will get a little back from Oregon. It’s nice to pay less tax.

  • Pennypincher March 14, 2016, 6:04 am

    Fascinating! Good to know all of this. Hope Mrs. RB40 isn’t snoozing on it! : )

    • retirebyforty March 14, 2016, 10:38 am

      She limped through the post. These investing articles are tough for her. It’s good for her to learn, though.

  • Dividend Growth Investor March 14, 2016, 7:14 am

    Hi Joe,

    You seem very close to earning $1,000/month in dividend income. But I seem to recall that you own funds as well, which earn a very sizeable dividend income, don’t you?

    I expect to live off dividend income in retirement. In fact, for a married couple filing jointly, if they earn $95,000 in qualified dividend income (and have no other source of income), they would end up paying absolutely zero in federal taxes.

    Isn’t passive income amazing? As if the government is giving you incentives to just retire early?

    Good luck in your investment journey!

    Dividend Growth Investor

    • retirebyforty March 14, 2016, 10:39 am

      My Vanguard funds are in my traditional and Roth IRA. So no tax impact at the moment. Passive income is awesome.

  • King March 14, 2016, 7:15 am

    Great post! For me, getting married helped get me into the 15% bracket. I was able to sell some old stocks tax free and reinvest into some new opportunities. I also started an IRA right before the end of 2015 just in case I need to reduce my taxable income because I cut it pretty close.

    What makes dividend qualify as long-term? Do you have to own the stock producing the dividend for over a year? If so, do stocks purchased from reinvested dividends that are less than a year old not qualify?

    • retirebyforty March 14, 2016, 10:41 am

      I think you need to own the dividend stock for 120 days or something like that. I need to do a little more research, but all my dividends are in the long-term category. I purchased some new stocks this year.

  • Ann March 14, 2016, 7:46 am

    Hi Joe,

    I have a question and an addition I’d like to make to your post. There is another way to avoid paying capital gains tax even with a higher income — using appreciated stock to make charitable gifts. If you want to make the charitable gift anyway, transfer your appreciated stock to your favorite charity. You avoid the capital gains AND get the normal charitable income tax deduction.

    Second, I am interested in starting a dividend portfolio but am concerned about the impact it will have on my childrens’ financial aid packages when they go off to college. It’s my understanding that your home, cars, and retirement accounts are largely ignored when financial aid is calculated but everything else is “fair game.” For that reason, I’ve been trying to keep most of our savings in our Roth IRAs and 401(k)s, with college savings in 529s. Do you see another way?

    I really enjoy following your blog — gives me a lot to think about!


    • retirebyforty March 14, 2016, 10:50 am

      That’s a great point. I will add it to the main article.
      We also prioritize our 401k and IRA. Once those are fully funded, then we’ll invest in dividend stocks with our brokerage account. Shielding your net worth in retirement accounts is the only way I know. Ahh… home equity doesn’t count on FAFSA. I guess you could pay extra on your mortgage.

  • Mr. Tako @ Mr. Tako Escapes March 14, 2016, 8:42 am

    Hi Joe! We have a significant dividend portfolio as well. This year we’ll probably have dividend income of $40-50k for the year. It should cover nearly all of our expenses.

    Last year was ridiculous – over $100k.

    Of course, living in a state with no income tax is a pretty big help!

    • retirebyforty March 14, 2016, 10:50 am

      Great job on your dividend portfolio. Your 2016 tax bill should be very small.

  • ER2019 March 14, 2016, 8:49 am

    Hi Joe,

    You don’t put many people to sleep. The taxation is very important for anyone to accumulate wealth. The long-term capital gain and qualified-dividend tax is the best gift from IRS. This is one of the reasons I shifted my investment from non long-term investment to dividend investment with DRIP (Dividend Re-Investment Plan). Once we retire, the 0% qualified-dividend tax rate should kick in for us.

    • retirebyforty March 14, 2016, 10:52 am

      Thanks for the encouragement. Mrs. RB40 had a difficult time with this post, but she did learned something. Your retirement is only a few years away. The long term capital gain tax will be a great factor for you then. Best wishes.

  • Dividend Reaper March 14, 2016, 9:02 am

    Oh how I would love to be able to take advantage of that 0% tax bracket for my investments. Unfortunately (and fortunately), I make more than that tax bracket and I’ve got to get in line to pay the tax just like so many others. Know of any other ways I could lower my taxes for the 15% bracket?

    -Dividend Reaper

    • retirebyforty March 14, 2016, 10:54 am

      Rental properties are great for lowering your tax. But that has a cut off point too. If you make too much money, you can’t use the deduction. Being self employed is good too. You can contribute much more to your solo 401k.
      I would be happy with making a lot of earned income for now. 🙂

  • Nathan @ Investment Hunting March 14, 2016, 9:10 am

    Harvest those dividends tax free as long as you can. I never realized that there was no tax on dividends for 10% to 15% tax brackets. This doesn’t apply to me, and I also have a huge tax whammy for living in California. However, this is interesting for my daughter who’s still in college and now a resident of Nevada (no state tax). I’ll start pushing her to build up her portfolio now to make tax free dividends. Thanks for sharing.

    • retirebyforty March 14, 2016, 10:54 am

      Good luck to your daughter. It would be great to start a dividend portfolio now while she is young.

  • SavvyFinancialLatina March 14, 2016, 9:19 am

    Really shows how powerful dividends are!

    • retirebyforty March 14, 2016, 10:55 am

      Yes, dividend is really great. Hopefully, the tax law stays the same for a long time to come.

  • Financial Nirvana Mama March 14, 2016, 10:24 am

    Interesting cost basis breakdown – Very creative, seeing your strategy of dissolving your stocks to leverage no capital gain taxes and then to rebuy it back to increase your cost basis. Canada doesn’t have this but we have a tax free savings account where gains can be taxed free up to a certain limit ($46500 of buying power for investments) The underlying reason is because we use after tax income to buy investments…- this doesn’t apply to corporations though.

  • cato March 14, 2016, 3:11 pm

    I’d like to add using municipal bonds are an effective way to get tax free dividends. I am a big fan of California municipal bonds.

    • retirebyforty March 15, 2016, 3:26 pm

      I like muni bonds too, but they are in a different class. I don’t really see them as dividend, more like interest.

  • Jason in Vancouver March 14, 2016, 6:06 pm

    Love the dividend talk and tax efficiency talk. In Canada, you get dividend tax credits at the federal and provincial level. In BC, you basically pay no taxes on most dividend income up to approximately $50k (each if a couple) if that’s your sole source of income. It gets a bit more complicated with additional income, dividend income gross up which potentially impacts some benefits eligibility, etc. But dividends only are pretty awesome at this $50k sweet spot. Beyond, capital gains are more tax advantaged but like FNM said we don’t have capital gains avoidance (save for typical offsetting losses) apart from our registered accounts.

    • retirebyforty March 15, 2016, 3:28 pm

      Thanks for your input. I don’t know much about the Canadian tax code. It’s great that you don’t have to pay tax on dividend income up to $50k.

  • EL March 15, 2016, 6:25 am

    Yes just another reason why I like dividend investing, favorable tax treatment. Most of my dividends are in tax deferred accounts so no issue today with paying for taxes, but I am slowly increasing the non tax deferred side of my passive income. Thank for sharing.

  • Ray March 15, 2016, 10:25 am

    Great article, this will be very helpful for me in planning a retirement income source. Thanks a lot and have a great day!!

  • Cynthia March 15, 2016, 1:12 pm

    Hi joe!
    I recently retired ( husband too) and for the past few years beg my financial planner for help who loves to refer me to my CPA!
    The CPA who I really like by the way, often says check with your financial planner!
    I am shocked that articles everywhere love to talk about how much you’ll need in retirement but no one likes to talk taxes!
    This is HUGE in my opinion! Now I find us facings RMD this year. I loved your article talking about how to draw it down BEFORE retiring. It’s not right for everyone but often someone may have a down year which you should take advantage of reducing it! So many questions no one covers. I read a lot too!
    Please keep up these important issues!
    Everyone one is fed max out your 401k and life will be great! My SS cut my pention by 50.00 a month because it is paid for by the
    Govt program. I used to work for the airlines which our pention was taken over by the govt.
    so many little bites out no one talks about.
    Don’t get me wrong I LOVE being retired at 62!

  • tyler March 16, 2016, 7:05 am

    When I first heard that you don’t have to pay taxes on dividend income I thought the person was pulling my leg. Now after looking into it I cannot wait until I’m getting much more income from dividends and living more on that than on my income because well less taxes is amazing. Thanks for the article

    • retirebyforty March 16, 2016, 10:30 am

      Yes, it’s true! Dividend income is awesome in so many ways.

  • Linda March 19, 2016, 2:21 pm

    RB40. Please help me understand as I couldn’t figure it out that one pay no tax on dividend income under $75,300.
    Total dividend income (so called Ordinary div. $10,445 in your case) reported on tax 1040 form line 9a, out of this amount, Qualified Dividends ($10,068 in your case) is on 9b (left column). I could not see Qualified Div. is subtracted, instead it asks for combine all right column from line 7 to 21 to get to gross income (which mean total dividend, without subtracting qualified div., is added to other income), on which you adjust with other deductions to arrive at taxable income.
    If you talk about dividend income pays no long term capital gain tax (<$75,300) then that's another story. Capital gain tax is when you sold stocks for gain. why one pays capital gain tax on dividend income when one hold stocks?
    a bit confused, thanks for your help.

    • retirebyforty March 19, 2016, 10:29 pm

      That’s just the tax code. Dividend income is taxed at the same rate as long term capital gain. The wealthy wrote the code to minimize their tax.
      From the IRS – Qualified dividends are the ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain.

      In the 1040 form, it all get calculated on line 44.

      • Phil December 11, 2016, 1:51 pm

        I’m confused. As I understand it, ordinary dividends are taxed as ordinary income, so your header “No tax on dividend income” is only half right. Even when you are in the 15% tax bracket, you’re still going to pay 15% tax on ORDINARY dividends. So you paid 15% taxes on your $10,455 of ordinary dividends you received, correct? It’s the QUALIFIED dividends ($10,968) that you managed to pay 0% on.

        • Phil December 11, 2016, 2:00 pm

          Oh, wait, I think I see the source of my confusion. In your article, you show
          Ordinary dividends: $10,445
          Qualified dividends: $10,068

          At first, I thought these were two separate amounts that you received for a total of $20,513, but I think what you really are saying is that you received $10,445 in dividends total, of which $10,068 were classified as qualified and $377 were classified as ordinary/non-qualified. Is this correct?

          • retirebyforty December 12, 2016, 9:08 am

            You’re correct! That’s the way the tax software had it. I think qualified dividends are part of ordinary dividends. Non-qualified was $377.

  • kevin thompson October 30, 2016, 6:59 pm

    Practical suggestions – I am thankful for the facts , Does anyone know where my company can access a blank IRS 1099-DIV form to edit ?

  • Silvio December 1, 2016, 5:54 pm

    Does anybody know whether or not Dividend Payments from IRA accounts increase the Gross Income (thus putting me in a higher tax bracket)?

    • retirebyforty December 1, 2016, 7:35 pm

      Your IRA should be tax protected. You will have to pay tax in the future when you withdraw from the traditional IRA. Check with your tax guy.

  • svenka December 4, 2016, 9:14 pm

    Very practical information! Do you know if the 0% capital gains would also apply to investment real estate? Eg lets say my taxable income is $0 (after exemptions/deductions) and profit is $75K from investment property so still within 15%, does that mean I pay no tax?

    • retirebyforty December 5, 2016, 9:04 am

      I’m 99% sure the rental income is treated differently. You still have to pay tax on that income. You should be able to offset a lot of it with depreciation, though. Check with your tax guy.

  • Pete February 9, 2017, 2:48 pm

    Great blog. Just did my Federal Taxes. My taxable income is $53,000, well under the qualified dividend tax rate of zero percent. But when I did my taxes the old fashion way – with a pencil, I followed the instructions and used the Qualified Dividends and Capital Gains Worksheet found on page 44 of the 1040 instruction booklet. After completing the worksheet I was told to add an additional $226 to my tax amount on line 44. My capital gains and qualified dividends were $2,272.00. So instead of zero tax – I pay $226? Any idea why the disconnect? Thanks

  • Pete February 9, 2017, 2:53 pm

    Sorry – just re-looked at the worksheet. I guess I should have stopped at line 11 on the worksheet. Clearly stating that I owe zero taxes on both the capital gains and qualified dividends. Thanks.

  • David March 1, 2017, 5:11 pm

    Interesting reading, still greek to me LOL. We file joint and make way to much to be able to claim the 0% dividends. All our dividends are all reinvested back into their funds. Why do I have to pay tax on these dividends? Won’t I have to pay tax on them again when I retire and start collectiong my dividends?
    Please explain how this works and people can retire at 40? I thought you can not collect on 401k till age 62 with out huge penalties.
    Thanks for your help

    • retirebyforty March 2, 2017, 10:00 am

      Yes… You have to pay tax when you retire and start collecting dividend. Our income is in the 15% tax bracket so we don’t have to pay tax on dividend. You need to plan for that.
      People can retire at 40 if they have other sources of income. We have income from our dividend, rentals, and my website. You can build a Roth IRA ladder to access your 401k without having to pay penalty. It takes time, though. Check it out.

  • Jesse Smith July 20, 2018, 4:32 am

    Hey Joe,

    What you’re describing by selling and re-buying XYZ is a wash sale and you can’t use this to avoid income tax. It’s technically illegal.

  • Jesse Smith July 20, 2018, 4:42 am

    I’m mistaken. It’s only a wash sale if there’s a capital loss. Carry on 🙂

  • Sammy Glavney December 20, 2018, 5:34 pm

    Not that I’m about to have this problem, but does the income you receive from dividends (qualified or not) count as the same as income you receive from labor? Like, if I’m married and my wife and I made 50k a year and then we received dividend income of 50k a year would that push us into the next tax bracket?

    • retirebyforty December 22, 2018, 11:03 pm

      No, the dividend income is taxed differently. It’s part of long-term capital gains. So you pay much less taxes than on earned income.
      It is still part of income and will push you into the next tax bracket. Please consult a tax CPA.
      Usually the dividend income is small enough that it rarely pushes us into the next bracket.

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