The short answer is that all dividend distributions are taxable in the year they are distributed whether reinvested or received in cash. Dividends are reported by the investment company managing them on Form 1099-DIV.
But Jeff, how can this be when I don’t personally receive the distributions because I’m enrolled in a dividend-reinvestment program?
Sorry, you’ll have to pay taxes on your reinvested dividends, anyway. Unfortunately, reinvested dividends aren’t subject to any specal tax breaks, credits or loopholes. This confuses and upsets many taxpayers. Even though you don’t technically have access to the reinvested funds, they are considered regular income for the purposes of taxation. One benefit though, your investment company that is buying new stock on your behalf with the dividends should include the reinvested dividends as part of your fund’s cost basis to avoid “double taxation.”
If you wish to avoid dividend taxation in the year of distribution, consider a sequestration of your reinvested dividends in a deductible (tax-protected) IRA savings plan. That way you will only need to pay taxes on the investments contained in these accounts when you begin to withdraw funds later in life when usually your tax rate is lower. Be mindful, however, that the maximum contributions for any combination of traditional or Roth (non-deductible) IRAs is currently $5,500 ($6,500 if over the age of 50).
For lots more tax help and advice in Jacksonville, Florida, Jeffrey Mitchell, Enrolled Agent, with 30 years federal tax experience is your local Jacksonville area tax expert.