I have decided that to put money into stocks this year to try to build some wealth outside of my retirement plans. I have some speculative stocks but I’m looking at some growth stocks with dividends e.g. GM, Proctor & Gamble, etc. and I’m going to have my dividends reinvested. For those not familiar, normally a dividend would be put in my cash account but now it is used to buy more stock so if a stock is trading at $20 and I have 10 shares with a $0.20 dividend then I “buy” 0.1 share.
Do I still pay income tax on the dividend the year I get it?
How does this affect my cost basis for the stock? Not only moneywise but the time factor (1 year means lower capital gains tax)
Also, if I decide to sell some shares of a stock, for taxes is it LIFO or FIFO?
Lastly, is there any way short of a retirement plan that I can make trades and not be taxed on the gains until I withdraw the money from my account?
Dividends are income, even if reinvested. See this article, scroll down to “taxation”. It would be taxed as ordinary income and not subject to capital gains rules until you sell the stock. That’s my read, anyway.
Yes, you are taxed on dividends the year they are paid, no matter if it is reinvested in the stock or if you direct that it is paid into your cash account.
I’m not sure I understand this question.
You can direct that your sale of shares are FIFO or LIFO at the time of sale. In my Schwab account, the default setting is FIFO, but you are prompted to make a choice at the time of sale.
I don’t think so. If you’re not trading within a retirement account, I think you’re taxed on any capital gain the year that you make the trade, regardless of whether you leave the cash in the account, take it out, or use it to buy another stock. But you can always sell a losing stock the same year in order to have that loss “cancel out” your capital gain.
You said this is outside of your retirement plans. Consequently, I would recommend that you NOT reinvest dividends automatically. If you reinvest, it will make tracking your cost basis much more difficult, for not much benefit. As an example, if you buy 100 shares at $50, your original cost basis is $50.00 per share plus brokerage commissions. If you don’t reinvest, and you sell in 3 years, or 15 or 30, your cost basis is still $50 per share. But if you get 2% dividends each year, you will have a different cost basis for each year’s purchase, as well as different holding periods. It’s simply not worth doing this for stock purchases. A 2% dividend would be two shares each year.
If you decide to go ahead with reinvestment or drip investing, make sure to keep a detailed spreadsheet for each stock, noting each and every purchase, whether direct or through reinvestment.
Note that I’m not saying you should never dollar cost average. But even that works better when you have larger “chunks” invested periodically, not a tiny amount annually. Let your dividends accumulate and combine them with new investment funds and buy another stock or another sizeable purchase of one of your favorite holdings.
Yes, you pay taxes on dividends each year they are paid out by the companies.
Every purchase is a different cost basis, with a different date.
With stocks (as opposed to mutual funds, where average cost basis is often used), you generally identify which shares you are selling. So, if you bought shares of IBM in 2000, 2005, 2010 and 2015 and sell some in 2017, you can pick which shares you are selling, with the appropriate purchase date and cost basis.
Not that I can think of. That’s one of the benefits of an IRA, 401k or other qualified retirement account. You don’t need to keep track of every transaction and gains are delayed until you make withdrawals.
1)If the money is invested in a non-retirement type of account such as a 401(k) or IRA, yes you would pay tax on the earnings even if you don’t take any of the money out.
2)Cost basis is what you paid for the stock. If you bought it at $10.00 a share and sell it at $20.00 a share, then you have a profit of $10.00. If the dividends are re-invested, the cost bases for those dividends would be at the date and amount the stock was purchased.
3)Just use the cost basis that was provided on the brokerage’s year-end tax statement.
4)Yes, any IRA, ROTH IRA, or 401(k) type of plan from your employer you can do this. A ROTH IRA, you don’t take any tax deduction putting the money in it, but when you take it out you don’t have to pay any tax on it.
I have a few mutual funds outside of any retirement account. I have my dividends and capital gains reinvested, and they are taxed at 15%. For extremely high income people, the tax rate is 20% (I think).
I’m not sure why someone would be all that concerned with the cost basis of their stock. I invest money in the funds every month, and I don’t expect to make withdrawals for several years. When I do sell, the mutual fund company figures out all of the info that I would need and reports it to me. And my company defaults to FIFO, but there may be options to change that (I haven’t really had a desire to change it).
The year-end tax reporting statement from the brokerage house takes care of all those calculations for you. You don’t need to manually do this yourself. It reports the cost basis, when you told it, and if it belongs in short-term or long-term Capital gains.
I use Turbotax and I download this directly from the brokerage house and review it in Turbotax. I’m not sitting there trying to figure out the cost basis of securities and what they were as dividends.
He said “any way short of a retirement plan”. IRAs, ROTHs and 401k plans are all retirement plans.
There are a number of tax-efficient investment options these days that would allow you to invest non-qualified money in an account that does so as efficiently as possible. You’d have to go through a broker-dealer to have access to them, though.
Best thing as I mention for the OP to do, it find a good broker and follow-up questions to them like this. Because while the answer might be “Yes, you can do that…” the real answer is it has to fit into your overall plan and objectives.
Just a warning, the default of FIFO is not generally the best way to determine the cost basis. Usually stock prices rise over time. That means the first bought generally were bought at the lowest price and have the smallest basis which makes your realized capital gain larger.
Generally speaking (unless you expect your tax rate to rise later) your best off deferring gains as long as possible. So the best method to use is “identified shares” selling the ones with the highest basis – perhaps even at a capital loss. But as a default LIFO probably beats FIFO.
So I think I get this
I buy 10 shares at $20. Cost basis $20/share
Later through my DRIP I get a $0.22 per share dividend which is reinvested for 0.1 shares at $22 per share. Results. I am taxed on $2.20 and that is the cost basis when I sell that 0.1 share.
And yes I track each transaction separately in a spreadsheet.
Oh one more question. For tax purposes is the trade fee part of the cost basis? I assume so.
Yes it is. If you buy 100 shares at $50, with a $9.95 trading commission, your cost basis is $5,009.95 ($5,000.00 plus $9.95). If you sell those shares at $60, with a $9.95 commission, your proceeds are $5,991.05 ($6,000 minus $9.95). Your gain is $980.10.
I don’t get why you are tracking all this separately in a spreadsheet if the brokerage house provides this information for you in a year-end tax statement?
I can’t answer for the OP, but I can tell you that my brokerage account doesn’t have accurate cost basis data for stocks I own, particularly ones I bought years ago. I keep track myself on a spreadsheet.
Exactly. IIRC brokerages were required to track basis starting only about five years ago. Oh they’ll report one when you sell, but I’ve already had to correct that fiction a few times when I’ve sold old shares.
That said, even if you don’t keep good records, is not that hard to reconstruct a basis I you know the starting amount and date. The dividends for publicly traded stocks are available, so you can build a spreadsheet.
I am really glad that brokerages now have to report cost basis. About 10 years ago a lot of people at my company including myself received letters from the IRS saying we owed 10s to 100s or thousands in taxes. That year the Turbo Tax instructions did not specify that we needed to send schedule d forms to the IRS. So the IRS assume that the cost basis of our ESPP shares was $0 instead of basically about 80% of the sale price. It was always a pain in the ass to determine the cost basis for those shares.