Are reinvested dividends income?

Yes rein­vest­ed div­i­dends are tax­able income.

Assuming you’re rein­vest­ing div­i­dends in a reg­u­lar tax­able account. If you’re using a 401k rollover / IRA account, then rein­vest­ed div­i­dends are not tax­able.

The thing is, you prob­a­bly mean to ask…

Will I be stuck with a big tax bill that I’m not pre­pared for at the end of the year if I rein­vest my div­i­dends?

If you are just get­ting start­ed invest­ing, prob­a­bly not.

Federal tax­es on div­i­dend income is 20% (state and local tax­es vary by munic­i­pal­i­ty). So, for a rough esti­mate you can assume you’ll owe 25% of div­i­dend income as tax­es.

If you’re just get­ting start­ed, like read­er Roshan J who sent me the fol­low­ing mes­sage recent­ly, and you have $500 in div­i­dend income, you’ll owe about $125 tax­es.

I was doing my tax­es over the week­end. I’ve been invest­ing in div­i­dend stocks for the past say year and a half. And in 2016 I got a total of about $500 in div­i­dends. Which was sur­pris­ing. Imagine doing this over many years? I can see that snow­ball effect real­ly com­ing through.

But, and it’s a big but, what you owe depends a lot more on how much you have tak­en out of your pay­check. Do you have a lot of excep­tions so that you get a big refund at the end of the year? Well, then your refund will be just a lit­tle small­er.

If you’re like me when I start­ed invest­ing, I found the deduc­tions tak­en out of my pay­check were so innacu­rate as to make the amount of tax­es I owe on div­i­dends a round­ing error. Meaning, I did­n’t con­sid­er div­i­dend income because they did­n’t make a mean­ing­ful dif­fer­ence in tax­es owed rel­a­tive to my paycheck’s tax­es.

Currently though, I have a mean­ing­ful amount of div­i­dend income out­side of my retire­ment account so I do pay quar­ter­ly esti­mat­ed tax­es. If you’re in a posi­tion to doing that, you should be work­ing with a tax per­son who can give you advice rel­e­vant to your per­son­al sit­u­a­tion.

Personally, my feel­ing is that if you’re just get­ting start­ed pay the tax­es out of pock­et as a way to accel­er­ate your wealth build­ing (instead of sell­ing stock or not rein­vest­ing all your div­i­dends in order to pay them).

When I first start­ed writ­ing The Elephant in the Room has a Paycheck I put togeth­er a short sto­ry about how we mea­sure the wrong things when eval­u­at­ing our invest­ments. Looking at rein­vest­ed div­i­dends as two sep­a­rate trans­ac­tions (div­i­dend income, then sep­a­rate­ly a stock pur­chase), while required to prop­er­ly pre­pare tax­es, isn’t the most use­ful way to think about rein­vest­ed div­i­dends.

That sto­ry got picked up a bit, and had over 32,000 views! You can read it on slideshare.