How do dividend tax rates work at break points?

Over at Bogleheads we read: 

How do dividend tax rates work at break points?

Post a reply

4 posts • Page 1 of 1

How do dividend tax rates work at break points?

by dmcmahon » Mon Sep 30, 2013 11:32 pm

Hypothetical 1: person has a high income due entirely to dividends.
Suppose the person is single and has $500k in dividend income. Is all 500k taxed at the 20% rate? What if the person has $401k of income - is that extra $1k triggering a tax rate in excess of 100% because it causes all of the prior 400k to be taxed at the 20% rate instead of 15% ?

Hypothetical 2: as above but with work income making up a portion of the total.
Suppose the person has $300k of regular income and $200k of dividends - same question re. the tax rate that applies to the $200k. Now suppose its $101k, just over the bracket for singles.

dmcmahon

Posts: 1681

Joined: 21 Mar 2008

Top

Re: How do dividend tax rates work at break points?

by 22twain » Tue Oct 01, 2013 12:36 am

dmcmahon wrote:Hypothetical 1: person has a high income due entirely to dividends.

I assume you mean qualified dividends. Ordinary dividends are taxable as ordinary income.

Suppose the person is single and has $500k in dividend income. Is all 500k taxed at the 20% rate?

No. 

What if the person has $401k of income

Assuming a single person, and that the $401K is the taxable income after subtracting the personal exemption and whatever deduction he's entitled to:

The first $36.25K is not taxed.
The next $400K - $36.25K = $363.75K is taxed at 15%, yielding $54,562.50 in tax.
The final $1 is taxed at 20%, yielding $0.20 in tax.

He also has to pay the new 3.8% "Medicare tax" on investment income above $200K, which in this case is $201,001, yielding $7638.04 in tax.

Total tax: $62,200.74.

22twain

Posts: 255

Joined: 10 May 2012

Top

Re: How do dividend tax rates work at break points?

by dmcmahon » Tue Oct 01, 2013 12:43 am

After much googling finally seem to have the answer:

http://www.forbes.com/sites/anthonynitt ... s-it-work/

Thank you 22! Wondered about this after looking at another tax-related thread.

dmcmahon

Posts: 1681

Joined: 21 Mar 2008

Top

Re: How do dividend tax rates work at break points?

by 22twain » Tue Oct 01, 2013 12:47 am

dmcmahon wrote:Hypothetical 2: as above but with work income making up a portion of the total.
Suppose the person has $300k of regular income and $200k of dividends

In this case the regular income "pushes" the dividends upwards in the brackets. Imagine putting all the income in a stack with the ordinary income at the bottom and the (qualified) dividends on top. Now he has:

$100K taxed at 15% = $15K
$100K taxed at 20% = $20K

The "Medicare tax" threshold applies to (modified adjusted) gross income, so all the dividends are above the threshold: $200K taxed at 3.8% = $7.6K.

Total tax (on the dividends) = $42.6K.