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Dividends 101 - The Beginner's Step-By-Step Overview of How Dividends Work

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The Dividend Tax Debate
Double Taxation Dividend Tax

The IRS taxes dividends twice: Once when the company earns the money, and again when paid out to stockholders! In other countries, companies get a tax deduction to encourage managements to reward owners instead of building empires on their dime.

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Dividends, like interest, are taxed at a person’s individual tax rate. Capital gain taxes, on the other hand, are assessed according to the length of time an investor held his investment and can be as low as half the rate levied on dividends income. This difference in tax treatment is another reason many investors opt for long-term equity holdings that reinvest capital into the business instead of paying it out in the form of a dividend; by avoiding the double-taxation, they can compound their wealth at a faster rate.

There is a significant dividend tax political controversy. The corporation paid income taxes on the profit it earned (original tax). The owners of the business then take that profit out for their personal use in the form of a dividend and are taxed at personal income tax rates (second tax). In effect, they have paid the government twice.

The proponents of the dividend tax argue that the wealthy, by definition, own significantly more investments than the poor. Therefore, it would be possible for someone to earn billions of dollars in dividend income and not pay a dime in Federal taxes. This, they say, is inherently unfair. The gap between the rich and the poor would explode over night.

For more information, read The Investor's Guide to the Dividend Tax - What the Dividend Tax Is and the Dividend Tax Rates. You may also want to read Dividend Tax - The Political Debate: Understanding the Double Taxation Fuss.

 

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