— -- Q: Is there a way to avoid paying taxes on stocks that pay a dividend? Do some ETFs reinvest dividends so you don't have to pay tax on them?
A: Most investors wouldn't say no if a company offered to send them a check. And that's kind of what dividends are like. But at the same time, paying taxes on that money isn't as popular.
What you're suggesting is a difficult request. You want to enjoy the benefit of the steady payment from a company you're invested in that comes in the form of dividends. But you don't want to pay taxes on that cash.
Certainly, you might be able to hire a clever accountant who can work this out for you. But for most people, paying taxes is part of the reality when it comes to dividends. The good thing is that most dividends paid by typical corporations qualify for a lower tax rate of 15%. That's well below the standard tax rates due on ordinary income.
But with all that said, there are some legal ways where you might be able to avoid paying taxes on your dividends. Those include:
•Don't make too much money. Taxpayers in the tax brackets below 25% qualify for the 0% tax rate on dividends. For 2011, you'd have to earn less than $34,500 as a single person or less than $69,000 for a married couple filing a joint return to be in a tax bracket below 25%. The IRS lists tax tables on its website.
•Use tax-shielded accounts. If you're saving money for retirement, and don't want to pay taxes on dividends, consider opening a Roth IRA. You contribute already-taxed money to a Roth IRA. Once the money is in there, you don't have to pay taxes as long as you take it out in accordance with the rules. If you have investments that generate large dividends, you might consider putting them in a Roth. If the money is to be used for education, you can invest it in a 529 college savings plan. That way, using a 529, when dividends are paid, you don't pay any tax either. But again, you must take the money out to pay for education, or face paying a fee.
You mention finding exchange-traded funds that reinvest dividends. That isn't going to solve your tax issue, though, since taxes are still due on dividends, even if the proceeds are reinvested.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at email@example.com. Follow Matt on Twitter at: twitter.com/mattkrantz