Qualified Dividends Reduces Taxable Income?

[hnzw_rui]

Was reading an article on GoCurryCracker on their 2014 tax return and I was surprised by how low their tax was ($0).

For kicks, I decided to do a theoretical 2014 return comparing two simple scenarios:

Scenario A.
Single, Standard Deduction
Earned Income: $87,050
Taxable Income: $76,900
Tax: $15,088
no other income, deductions and credits

Scenario B.
Single, Standard Deduction
Earned Income: $87,050
Qualified Dividends: $80,000
Taxable Income: $76,900
Tax: $6,000
AMT: $0
no other income, deductions and credits

Forms used:
Form 1040
Qualified Dividends and Capital Gain Tax Worksheet-Line 44 (Intructions 1040, p43)
Form 6251

So basically, the person who only has $87K income through work has to pay $15K in federal taxes while the one who received $167K combined income from work and qualified dividends has to pay just $6K. Is this correct or did I mess up with my calculations somewhere?

Granted, assuming the portfolio is all on VTI (~2% div, iirc) you need $4M to generate $80K in dividends so the tax return is somewhat unrealistic. I sure as heck wouldn't be working for peanuts if I had that much in my portfolio.

 

[target2019]

Your calcs are correct. Single tax is harsh. A 401k should get maxed whenever possible. However, most young persons won't do that.

If you compare the invest example to two salaries of 87050 and 80000, the tax would be 28000 for a married couple. Better to marry someone with 4M in investments who does not work.

 

[RunningBum]

No way this is correct. How did you calculate it? I used Turbo Tax taxccaster, and all I entered was 87,050 for "Your total taxable wages" and then for the 2nd scenario I added 80,000 for qualified dividends. Single, age 40. They showed:

Scenario A

• Total Income $87,050
• Total Deductions $6,300
• Total Exemptions $4,000
• Taxable Income $76,750

• Regular Taxes $14,988

Scenario B

• Total Income $167,050
• Total Deductions $6,300
• Total Exemptions $4,000
• Taxable Income $156,750

• Regular Taxes $26,988

They showed the $80,000 as part of regular income, but under the covers the Cap Gains and Divs worksheet handles the dividends appropriately.

I suspect you didn't really include the 87,050 in earned income because when I put 0 for that I got:

• Total Income $80,000
• Total Deductions $6,300
• Total Exemptions $4,000
• Taxable Income $69,700

• Regular Taxes $4,838

 

[RunningBum]

The minor differences were because I used 2015. When I selected the 2014 tab, I got your 15,088 tax for the first scenario, and 27,088 for scenario B. 80,000@15% is $12,000 so this makes sense to me that the cap gains, being above the 15% line, are all taxed at 15%.

 

[RunningBum]

I got your second scenario to match by using 7050 taxable wages. That makes 87050 earned income when combined with the 80000 dividends. I don't think this is what you meant though, because you said

So basically, the person who only has $87K income through work has to pay $15K in federal taxes while the one who received $167K combined income from work and qualified dividends has to pay just $6K.

If you have 80K in dividends instead of 80K of wages, it is very believable that you would pay 9K less in taxes because of the lower tax rate on dividends for this situation. But not when that 80K dividends is in addition to the same wages.

So you either messed up your calcs that way, or worded scenario B incorrectly.

 

[rbmrtn]

I would say not correct. Qualified Dividend income is tax if you stay in or below the 15% bracket for total income. A single exceeds the 15% bracket at around $45k ( my own experience says it is not right )

Also run a quick check with taxcaster, it also says no

https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

 

[rbmrtn]

If you have 80K in dividends instead of 80K of wages, it is very believable that you would pay 9K less in taxes because of the lower tax rate on dividends for this situation. But not when that 80K dividends is in addition to the same wages.

So you either messed up your calcs that way, or worded scenario B incorrectly.

Yes if you run taxcaster with $45k of QD only then there is 0 tax.

 

[karluk]

asically, the person who only has $87K income through work has to pay $15K in federal taxes while the one who received $167K combined income from work and qualified dividends has to pay just $6K. Is this correct or did I mess up with my calculations somewhere?

As RunningBum has pointed out, your calculations are mistaken. In the simple scenario you've outlined, a single person with $167k in income will pay more taxes, not less, than a single person with $87k in income.

You don't include a link to the article you were reading on gocurrycracker.com, but a quick search of their website indicates that they have a reasonably good understanding of the basics of the tax law:

Never Pay Taxes Again - Go Curry Cracker!Go Curry Cracker!

a married couple can have $19,500 a year in income AND $70,700 in investment income, TAX FREE (if that isn’t a strong signal to not work, I don’t know what is.)

 

[Danmar]

Interesting. In Canada, taxes on qualified divs are actually negative up to about $45,000 and thereafter at reduced positive rates. I don't believe this is the case in the US where a flat 15% is applied to qualified divs.
For those interested, the Canadian system basically credits the individual taxpayer with the corporate taxes paid by the div payer. Divs are paid out of after tax corp income. At low personal rates this credit can be higher than the personal tax amount accruing. Pretty good approach IMHO. It results in total taxes paid (both Corp and personal) equal to what an individual would pay if he earned the total income directly.

 

[target2019]

When I did the other side of the calculation for 87050 + 80000 QDI, I get 26981 in tax form HRBlock calculator. That's about $12K more in taxes from Case A where there is just 87050 in earned income.

If Case B is all earned income for a single, then $36961 approximately is the tax bill. That might be the situation OP was trying to get at.

 

[Mulligan]

Taxes (along with a belief that long rates aren't going to move upward appreciably for years to come) is the reason I finally threw the towel in on IBonds and CDs and went to qualified dividend preferred stock. I am butting up to edge of 28% tax bracket in retirement and will breach it shortly. I am not going to tolerate 2% interest rates and then promptly give back 25-28% (plus additional 6% state on CDs). I will take my chances with 6-7% dividends and only paying the 15% instead.


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[hnzw_rui]

Ok, scratch that. The reason I was getting lower taxes is because I didn't know that Qualified Dividends (Box 1b) is also included in Total Ordinary Dividends (Box 1a) so on the fake 1099-DIV, I had 0 in Box 1a and $80K in 1b so on the 1040, I had 0 in Line 9a and $80K in 9b instead of having $80K on both.

 

[karluk]

It may be of interest to note that the net negative tax rate on LTCG envisioned in the OP can actually materialize under the right circumstances. I am currently in such a situation. Earlier this year I sold some shares of VTSAX, realizing a LTCG of (roughly) $3,000. With the recent market slide, the remaining shares now have an unrealized loss of about the same $3,000. If I realize the loss by selling my shares before the end of the year, the gain and loss will approximately cancel, leaving me with no net taxes due on the sales.

But that would be a mistaken strategy. It is better to wait until January, 2016, to realize the loss. Since I am in the 15% tax bracket, I will owe $0 in Federal tax on the $3,000 gain on my 2015 returns, and in 2016 I will get a $3,000 deduction from ordinary income on the loss. In the 15% tax bracket that's worth $450 in taxes saved.

That's pretty cool. As things stand right now, I have neither a profit nor a loss from my VTSAX investments, since my realized gain is offset by the unrealized loss. But I can manipulate the tax laws to get a $450 tax deduction in 2016 without needing the stock market to rally at all.

 

[Sunset]

Interesting. In Canada, taxes on qualified divs are actually negative up to about $45,000 and thereafter at reduced positive rates. I don't believe this is the case in the US where a flat 15% is applied to qualified divs.
.....

Canada has this weird thing of you report 25% more divs than you actually got, and then get a tax credit (like cash) applied at the end.

Qualified divs are taxed at various rates, if your total income for a couple is (rounded off) 100K and its all divs, the tax rate is 0%

If your tax rate is 0%, or 10% or 15% and your total income including the div's is less than 100K (rounded off) for a couple, then the div's are taxed at 0%

 

[kcowan]

Yes we have blue chip dividend paying stocks in our portfolio to capitalize on this tax advantage. Other stocks and bonds are in our tax-sheltered accounts. At $72K, there is clawback of the old age pension which negates the dividend tax advantage.

 

[Danmar]

Canada has this weird thing of you report 25% more divs than you actually got, and then get a tax credit (like cash) applied at the end.

Qualified divs are taxed at various rates, if your total income for a couple is (rounded off) 100K and its all divs, the tax rate is 0%

If your tax rate is 0%, or 10% or 15% and your total income including the div's is less than 100K (rounded off) for a couple, then the div's are taxed at 0%

I wouldn't call it weird, rather it is a rational approach to prevent double taxation. The qualified div is "grossed up" to make it equivalent to the before tax equivalent earnings that the corp had to earn to pay the div. This amount is adjusted each year in advance depending on the corp tax rates. It is not 25%, more like 40-45%. The individual includes this higher amount in income but then gets credit for the corporate taxes. It results in lower taxation by the individual. In fact it will result in a negative tax
(Eg an overall reduction in taxes otherwise owing) for incomes up to about $45,000.
Agree it is a little more complicated but much more rational than some other arbitrary approaches.