Depending upon the size and complexity of your investment portfolio, the stocks and mutual funds that you own may serve to complicate your year-end tax calculations. Figuring out your tax liability on your equity investments isn't simply a matter of adding up the amount by which your holdings increased or decreased in value during the year. In actuality, it's a multi-step process that involves several related calculations. A complex stock portfolio often demands the assistance of a seasoned tax professional. In fact, you probably won't be able to maximize your returns and minimize your year-end tax liability without seeking the advice of an investment advisor throughout the year.
However, there are plenty of portfolio-related tax calculations that you can make on your own. Compared to capital gains and carried interest, dividends are actually fairly easy to understand. Historically, dividends have been taxed at the same marginal rates at which "regular" types of income are calculated.
Until the early 2000s, determining the total dividend-related tax liability of a given portfolio was a simple process. This calculation simply involved adding up the total value of the dividends issued and dividing by the applicable marginal tax rate. If you earned $100,000 in dividends over the course of the tax year, your dividends would be added to your other income streams and taxed accordingly. For the purposes of taxation, dividends were indistinguishable from salary and interest earnings.
Thanks to the passage of two wide-ranging tax laws, this arrangement changed in 2003. The new tax laws broke dividends into two distinct categories: "qualified" and "unqualified." Unqualified dividends continued to be taxed as regular income. On the other hand, qualified dividends were subject to markedly lower tax rates. Along with long-term capital gains taxes, the tax rates on qualified dividends dropped to a flat 15 percent. Unlike the rates at which regular streams of income were taxed, the rate at which qualified dividends were taxed did not depend upon each dividend-earner's total income. In other words, two taxpayers who earned vastly different amounts of money would each pay a flat 15 percent tax rate on the dividends that they earned.
As a result of a still-newer law, this arrangement has been upended once more. Barring any future tax cuts or tax reform initiatives, the rate at which dividends are taxed has been allowed to rise. For the foreseeable future, qualified and unqualified dividends will be taxed as regular income.