When your money is in the market, or when you own a business, you generally earn income in two ways: capital gains and dividends. While these concepts may seem straightforward, understanding how they are taxed can help you plan ahead and avoid surprises on your tax bill.

Quick Takeaways:

• Sell smart, pay less: Capital gains are only taxed when you sell; long-term holdings get lower rates.
• Income while you wait: Dividends provide ongoing taxable income, often at favorable rates if qualified.
• Plan ahead: Knowing the tax treatment of gains and dividends helps you avoid unexpected tax bills.
• Stay organized: Accurate record-keeping of sales, dividends, and holding periods is crucial for tax reporting.

Capital Gains: Taxed When You Sell

A capital gain occurs when you sell an asset, like stock, real estate, or even part of a business, for more than you paid. The gain is taxable only at the time of sale.

How capital gains are taxed:

• Short-term gains (held ≤ 1 year): taxed as ordinary income
• Long-term gains (held > 1 year): taxed at lower rates (0%, 15%, or 20%)

For business owners, capital gains matter during business sales, stock redemptions, or ownership transitions, where timing can have a significant tax impact.

Pro tip: Tax-loss harvesting (selling losing investments to offset gains) can reduce your capital gains tax, but IRS rules like the wash-sale restriction must be followed.

Dividends: Taxed While You Hold

Dividends are payments a company makes to shareholders from its profits. Even if you don’t sell your stock, dividend income is taxable in the year it is received, whether paid in cash or reinvested.

How dividends are taxed:

• Ordinary dividends: taxed at ordinary income rates.
• Qualified dividends: taxed at lower capital gains rates (most U.S. stock dividends fall into this category).

For business owners, C-Corporation payouts may come in the form of dividends rather than salary, which are subject to dividend taxation. S-Corporation owners, in contrast, typically receive distributions. These distributions are generally not taxable if the owner has sufficient basis; however, S-Corporation income is taxed directly to the owners through pass-through taxation, whether or not the earnings are actually distributed.

Tax insight: Reinvested dividends are still taxable; you don’t avoid taxes just by keeping the cash invested.

To put it simply, capital gains are taxed when you sell, dividends are taxed as you receive them. Both have unique tax considerations, and understanding these rules is key to accurate reporting and planning.