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How are ETF dividends taxed?​

​ETF dividends are taxed based on two key factors: the type of dividends paid and your tax situation. Here’s how it works:

1. Qualified vs. Non-Qualified (Ordinary) Dividends

ETFs distribute dividends based on the dividends they receive from the underlying stocks in the fund. These dividends are classified as:

Qualified Dividends (Taxed at Lower Rates)
  • Paid by U.S. companies (or qualified foreign companies) on stocks held for a certain period (usually at least 61 days).
  • Taxed at long-term capital gains rates (0%, 15%, or 20%, depending on your income bracket).

Non-Qualified (Ordinary) Dividends (Taxed at Higher Rates)
  • Dividends that don’t meet the holding period or come from non-qualified foreign stocks, REITs, and bond ETFs.
  • Taxed at ordinary income tax rates (same as wages, ranging from 10% to 37%).
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Impact: ETFs that track indexes with high-dividend-paying stocks (e.g., S&P 500 ETFs) often have a mix of qualified and non-qualified dividends, affecting tax efficiency.

2. Tax Treatment Based on ETF Type

Stock ETFs
  • Typically pay a mix of qualified and non-qualified dividends.
  • U.S. equity ETFs are usually more tax-efficient than international or REIT ETFs.

REIT ETFs (Real Estate Investment Trusts)
  • REIT dividends are usually non-qualified and taxed at ordinary income rates.
  • However, they may qualify for a 20% pass-through deduction under the U.S. tax code.

Bond ETFs
  • Pay interest income, not dividends, which is taxed at ordinary income rates.
  • Municipal bond ETFs may offer tax-free income at the federal (and sometimes state) level.

International ETFs
  • May be subject to foreign withholding taxes, but investors may receive a foreign tax credit to offset some of these taxes.

3. How Are ETF Dividends Reported?
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  • ETFs issue a 1099-DIV tax form each year.
  • This form breaks down qualified dividends, non-qualified dividends, and capital gains distributions.

4. Tax-Advantaged Accounts (IRAs, 401(k)s, HSAs, etc.)
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  • If you hold ETFs in a tax-advantaged account (e.g., IRA, Roth IRA, or 401(k)), dividends can grow tax-deferred or even tax-free (Roth IRA).
  • This is a great way to avoid yearly dividend taxes and maximize growth.

Key Takeaways

Qualified dividends = lower tax rates (long-term capital gains rates).
Non-qualified dividends = higher tax rates (ordinary income rates).
REIT and bond ETF dividends are usually taxed at higher rates.
Holding ETFs in a tax-advantaged account can help minimize or eliminate dividend taxes.
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