Advertiser disclosure
Terms and Restrictions Apply
Physician on FIRE has partnered with CardRatings for our coverage of credit card products. Physician on FIRE and CardRatings may receive a commission from card issuers.Some or all of the card offers that appear on the website are from advertisers. Compensation may impact on how and where card products appear on the site. POF does not include all card companies or all available card offers. Credit Card Providers determine the underwriting criteria necessary for approval, you should review each Provider’s terms and conditions to determine which card works for you and your personal financial situation.
Editorial Disclosure: Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed, or approved by any of these entities.
- April 25, 2016
Today, I’d like to explore strategies to avoid taxes on capital gains and dividends. Both of these investment returns come in two flavors. Short-term capital gains and ordinary non-qualified dividends are taxed like income, so it’s awfully difficult to avoid taxes on those.
Long-term capital gains (LTCG), realized when you sell an asset you’ve held for more than a year, and qualified dividends (QD) are a different variety. The tax treatment on them can be much more favorable.
It can also be not so favorable. Typically, even though these taxes are generally lower than income tax, you can expect to pay at least 15% on them, and as much as about 37% if you happen to make millions and live in California. How so?
In addition to the standard 15% tax on LTCG and QD, the following apply:
- 3.8% NIIT tax (a.k.a. ACA surtax)for individuals with AGI of at least $200,000, or couples with an AGI of at least $250,000
- Additional 5% tax for those in the top federal income tax bracket
- State income tax in most states, which runs as high as 13.3%
Although I’m not in the top federal income tax bracket, I pay the 3.8% and a hefty state income tax anytime I realize LTCG or a QD in my taxable account. It’s important to note that you won’t see these taxes in a Roth or tax-deferred account. This Top 5 list applies to a taxable account.
The Top 5 Ways to Pay No Tax On Capital Gains & Dividends
1. Keep taxable income low (and be married).
I’m not trying to say you should let the tax tail wag the dog.
By all means, earn what you can while you’re accumulating wealth, and avoid turnover in your taxable account (buy and hold). The time to keep taxable income low is in retirement. If a substantial portion of your nest egg is in taxable and Roth dollars, you should be able to keep your taxable income far below your annual budget.
In 2020, a couple can have a taxable income of $80,000 and pay no tax on all LTCG and QD. While this may sound low to you, we learned in The Taxman Leaveth how a couple with a well-constructed portfolio can easily spend six figures while keeping taxable income low.
For a single filer, you can only have half the taxable income to be in the 0% LTCG & QD bracket. Keeping taxable income under $40,000 is a big ask for most retired physicians, but it makes it easy to live off dividends tax-free. Love and marriage pays. 
2. Tax Loss Harvest / Tax Gain Harvest.
On January 20th, 2016 I made two quick exchanges in my Vanguard taxable account. I sold shares of VFIAX (S&P 500 Index) to buy shares of VTSAX (Total Stock Market). I also sold shares of VTMGX (Developed International index) to buy shares of VFWAX (International Index).
In two minutes, I had a paper loss of about $39,000, but remained invested in assets that correlate very well to my original position.
That $39,000 capital loss can be used to offset future LTCG, or better yet, $3,000 of earned income every year for 13 years. Behold the power of tax loss harvesting.
Tax gain harvesting is a strategy to utilize in early retirement. If you are in the fortunate position of having taxable income below the threshold above ($77,200 for joint filers in 2018), take some capital gains to reset your cost basis and pay no tax. Do this until your taxable income has reached the magic number. Another option is to make Roth conversions to fill the bracket. Look at your situation and do what works for you. Just don’t leave that bracket unfilled if you can help it.
If you go over by a few hundred dollars, don’t worry. Having a taxable income of $81,000 doesn’t mean you pay 15% on all LTCG & QD, just on the $1,000 overage.
3. Donate Appreciated Shares to Charity.
You might not be in love with willfully parting with your hard earned money, but trust me, it’s better than option #4. It’s also true that giving, or joyful generosity, is a key contributor to our happiness.
When you donate appreciated assets with long-term gains, capital gains taxes aren’t paid by the giver or receiver. Win, win. Just be sure the asset has been held for at least a year or you will only be able to deduct the cost basis of the asset (what you paid for it) as opposed to the current value.
Giving stocks or mutual funds directly to a charity can be cumbersome. I advocate the use of a Donor Advised Fundto facilitate the transaction. I’ve had several DAFs, but I prefer Fidelity’sfor its low costs and low $50 minimum grant.
4. Die.
That’s right. Buy the farm. Kick the bucket. When assets in a taxable account are passed on to heirs in the next generation, the cost basis is reset to the current value. The assets can then be sold, tax free. The tax savings can be huge.
For example, if I had been a smart baby and purchased $10,000 of an S&P 500 index fund when I was born in 1975, it would be worth nearly $1 Million today ($953,00 with dividends reinvested as of January, 2018).
Selling it today, I would incur over $250,000 in taxes. But if I were to start pushing up daisies, leaving the fundto my children, no tax would be owed, and the cost basis would be reset to the value at the time of my untimely demise (unless the estate is exceedingly large and we’re looking at estate taxes).
A couple caveats. The first index fund wasn’tsold until the year after I was born, when John Bogle of Vanguard fame created the First Index Investment Trust. Also, I don’t recommend death as a tax avoidance strategy, but the knowledge could be helpful in estate planning. Don’t give those highly appreciated assets away while alive. Leave them for your heirs to inherit tax free.
Interestingly, when passing along to a surviving spouse, the cost-basis is stepped up to the halfway point between the initial cost and the current valuation.
Find a Great Credit Card
Manage Your Student Loans
Earn More Money
5. Buy equities with low or no dividend.
The aforementioned strategies require something you may not be prepared to do, like retire, give your 
money away, or keel over. What’s a doc to do while working, saving, and staying alive?
You can do your best to invest in equities that don’t return much to investors beyond growth in the intrinsic value of the stock. Some companies pay no dividends. Warren Buffett’s Berkshire Hathaway is famous for being one of them. Owning BRK stock, you will get all the benefits of the total return, and none of the tax drag that dividend producing assets give you.
Growth stocks are another asset class that tends to offer lower dividends compared to the total market and value stocks. Of course, if growth stocks underperform (see the year 2000), the tax benefit might be outweighed by poor performance.
Preparing for and Protecting a Child’s Financial Future
How To Utilize Your Professional Skills as a Retiree
Which is Better? Chase Sapphire Preferred versus Sapphire Reserve
Are you able to take advantage of any of these? I currently #2,3, and to some extent #5 by sticking with tax efficient index funds in the taxable account. I look forward to the possibility of #1, and hope to stave off #4 as long as possible. Have you got a #6? Find the comment box below and let us know!
Share this post:
Share this post:
38 thoughts on “Top 5 Ways to Pay No Tax on Capital Gains & Dividends”
[…] age at which their children will be able to access the funds. With respect to UTMA accounts,capital gains, dividends, and interest accrued in them are taxable to the child’s parents regardless of who […]
Reply
Subscribe to get more great content like this, an awesome spreadsheet, and more!
[…] age at which their children will be able to access the funds. With respect to UTMA accounts,capital gains, dividends, and interest accrued in them are taxable to the child’s parents regardless of who […]
Reply
Pingback: Come On, Get Happy: Money Lessons from the World Happiness Report
Pingback: Come On, Get Happy: Money Lessons from the World Happiness Report - StatusZine
Pingback: Come On, Get Happy: Money Lessons from the World Happiness Report - Corruption Buzz
Pingback: Come On, Get Happy: Money Lessons from the World Happiness Report - My Intermix
Pingback: Come On, Get Glad: Cash Classes from the World Happiness Report - Yeah Daily
Pingback: Come On, Get Happy: Money Lessons from the World Happiness Report - misterthink
Pingback: Come On, Get Happy: Money Lessons from the World Happiness Report - Passive Income MD
Pingback: The Worst Money Decisions I Could Make - The Physician Philosopher
Hi PoF,
I keep coming back to this article and learn something every time! I have questions about the ‘substantially similar’ funds.
Does it have to be the exact same fund in an IRA/401K in order to trigger a potential wash if you are doing automatic reinvestments in tax-deferred accounts? For example, let’s say I hold SPY ETF in my tax deferred accounts and VOO ETF in my taxable account. I automatically reinvest in SPY; in the same 30 days I take TLH on VOO and buy VTI. Since both SPY and VOO track S&P 500, have I triggered a wash sale because SPY and VOO are considered substantially similar? Or as long as I’m not trading SPY in my taxable account (and not VOO or VTI in tax deferred), I would be ok?
What if all 3 funds tracked different indexes (e.g., use VV instead of SPY in the tax deferred accounts)? Would that be safe to avoid a wash sale? Thanks!
Reply
If the two funds follow the exact same index, I would think that could trigger a wash sale. It’s definitely a gray area that’s discussed much more in this post.
Cheers!
-PoFReply
Pingback: My 5 Current and 3 Future Passive Income Streams – TableTop Wealth
Pingback: Top 10 Ways to Lower Your Taxes – The Trading Broadcast
Great article. Are dividends taxed even if you’re still holding the stock/fund/etc or only when you sell?
Reply
Dividends are taxed in the year in which you receive them, which is why high-earners should not invest for dividends (at least in a taxable brokerage account) while working.
More info: https://www.physicianonfire.com/selling-shares-beats-collecting-dividends/
Cheers!
-PoFReply
Fortunately and unfortunately, we will be making about $500k over the cap gains exclusion on the sale of our home and none of our investments are losers (no ability to tax-loss harvest). We live in CA so our tax bill will be hefty, around $100k. I can put some of it into a DAF but what about the rest? We are buying another home but I don’t think that helps us since it’s not an investment property. What would you do in this case to save on cap gains taxes?
Reply
What about growth in a taxable account? I’m certainly feeling the tax drag, but shouldn’t we try to out-grow it with solid gains???
Reply
No doubt that death can be a great tax strategy! I have seen people gift real estate before they die. The problem with this is that the basis carries over to the recipient. But if the person died and the beneficiary inherited the real estate it would have received stepped up basis. Make sure that you consider death when tax planning!
Reply
Any tips on minimizing taxes on short-term capital gains? Or is that just a myth?
Reply
Option 6: Gift appreciated shares up to the current limit (in 2017 that is $14000 per spouse, so up to $28,000 per recipient) to someone who is in the 15% tax bracket… children, grandchildren with tuition to pay etc. who can avoid the tax upon selling the shares. Tax avoidance is a team/family sport 😉
Reply
Fantastic suggestion, Will.
I’m not in a position to do that yet, but perhaps when my children have grown up and earned their own FI money, we can consider that strategy. If we ever want to help out with certain big expenses (wedding, home down payment), that would be the way to go, as well.
Right now, we use up most of our gift tax exclusion on the 529s, but they are nearly fully funded with the $100,000 we have planned for each of them.
Cheers!
-PoFReply
I have a basic question about selling stocks and dividend income coming from taxable account like 401k. When you withdraw qualified dividends and capital gains from a tax deferred account, are they still treated as long term capital gains and qualified dividends or they are just income? Assuming you can withdraw from it without penalty.
Thanks!Reply
Anything drawn from a tax deferred account (non-Roth 401(k), 457(b), IRA) will be taxed as ordinary income. It doesn’t matter if the money comes from your initial investment or returns on the investment in the form of dividends or capital gains.
Selling, or collecting dividends and gains from a taxable account is where you can see some favorable tax treatment, but remember that it’s already post-tax money.
Best,
-PoFReply
#1 is exactly where I expect to be next year. (without the married part of course). If I “accidentally” earn too much money next year, through freelance efforts, it sounds like a good problem to me. Happy to pay the extra taxes.
I don’t believe that I have a nest egg to sustain sub-15% federal tax bracket forever, but I’m also not sure what my ongoing lifestyle will cost once I get out of expensive California.
At the same time though, I almost feel like I’m more likely to pursue some sort of new career because to have a new challenge and feel a sense of purpose, rather than because I’m drawing down a portfolio too fast.
A curious theoretical question about tax gain harvesting. Do you have to wait a period of time before you can reinvest back in the fund? I guess it probably depends on the individual fund.
Reply
I don’t believe the IRS code has any rules on that, but you’re right, fund families and individual funds may have rules about repurchasing. If you use TLH partners, you could use the same partners to TLG from one fund to its partner without any worry.
California can certainly be expensive. Do you know where you’re headed next?
Best,
-PoFReply
POF,
There are definitely some variables here, if you asked me today, I’d tell you I’m inclined to stay somewhere west so that I’m not too far from my family, so somewhere like Phoenix comes to mind. Plus, there are a ton of normal age retirees so the health care must be great, right? Ha. I actually didn’t go to the doctor once in 2016.
Phoenix was actually where I was originally intending to move after college, but the whole meltdown happened. But I’m totally open to falling in love with somewhere not so close to home. That’s a big reason for the road trip. Determining if there is a place that I would choose to live rather than just default to living somewhere because it’s near where I grew up. The exciting part is that unless I see a a particularly exciting job ad somewhere specific, I won’t be making this decision based on where a job is, as for most of the last 7 years I’ve lived in the same city because it was close to work.
Reply
Good summary PoF. For high-income W2 earners gunning for FIRE, tax loss harvesting is a big deal. It is likely they are saving in a taxable account and getting hit with additional cap gains. Losses can offset these and run 3k in the negative. Then in retirement they can be strategically sold to fill up the lower tax brackets and hopefully get taxed at 0%.
Reply
That’s the idea, Happy Philosopher. Ideally, capital gains are avoided in the taxable account until retirement. A good reason to steer clear of actively managed funds in a taxable account.
Using Vanguard index funds exclusively in my taxable account, I’ve taken 0 capital gains in the last few years, but I’ve banked many years worth of losses.
Cheers!
PoFReply
We are definitely aiming to keep our income low in retirement, both for tax purposes and for ACA subsidies. While we (a married couple) can take out substantially more than we need from our investments in retirement, we can’t do that AND still get a well-subsidized ACA plan, at least according to the current rules which could certainly change. So we’re currently in the process of trying to hone in on our sweet spot: the income level in retirement where we can get the best quality of life along with the lowest taxes and highest subsidy. This all relates to your point about tax loss and gain harvesting — we don’t want to harvest gains now because we’re in a high bracket at the moment, and we don’t want to harvest losses because it’s advantageous over time to have a higher cost basis to minimize our gains and income for ACA purposes. It’s a lot to figure out, but worth considering!
Reply
The best you can do is plan for the future based on today’s rules, knowing that rules will probably change.
I completely agree with not harvesting gains now; I avoid capital gains at all costs, and I wish I could do away with the dividends while maintaining the diversification and low costs of the Vanguard index funds. As far as TLH, I think the benefit of deducting $3000 in income now in a high tax bracket would more than offset possibly paying LTCG on $3000 later, unless it pushes you over an ACA subsidy cliff. Last I checked the subsidy for a couple disappeared in the low $60k (MAGI) range, but for a family of 4 (which we’ll be for quite a few years), it’s around $100k, well above the 15% tax bracket. That sweet spot might be a moving target, but you’re closer to retirement than me, so you can do some more concrete planning.
Best,
-PoFReply
Good reading.
I am reminded of the old adage
“In life, one can only be certain of two things – death and taxes”.
To your point #4, it should be “Death and NO taxes”
I think I am with you and leaning towards not dying…..?Reply
You have chosen wisely.
Reply
Nice J-Hook on the rope there. Is that a recent photo and are you training for an event?
Still trying to wrap my head around Tax Loss Harvesting. It hasn’t been something I have to worry about, yet.
Reply
Is that what that maneuver’s called? The picture is from last year. After failing to climb the wet rope to the top in my first Spartan race, I felt compelled to install a rope swing for the kids. It just happens to double as a climbing rope 🙂 Failure is a powerful motivator. And yes, I completed the wet rope climb in my second Spartan race. I’m slated for a Tough Mudder this summer. I’m not specifically training for it, but doing my best to stay in shape like I always try to do.
TLH is a fairly recent addition to my bag of tricks, but I was able to take advantage of some opportunities in the down markets we had last fall and again this winter.
Best,
PoFReply
The only thing worse than paying taxes is not having to pay taxes. 😉
Reply
The 15% tax bracket is a great little caveat in the tax code. I sure hope it’s still around when I’m ready to take advantage of it.
I do try to keep my higher dividend paying funds in my tax deferred accounts rather than my taxable account. Otherwise that tax can add up to some real money.
But one thing I could look into and do better with is the tax loss harvesting. I’ve never really paid that much attention but definitely should. Your example was good and that’s a pretty big income offset without really changing your portfolio.
Thanks for the post PoF.
The Green SwanReply
Hello Green Swan,
I’m hoping to be able to take advantage of 0% capital gains in the 15% bracket in the early part of the 2020s, assuming again that the law doesn’t change. The biggest enemy to The Plan to keep taxable income low might just be this website. I can live with that.
A more thorough treatment of Tax Loss Harvesting is in my list of topics to write about. There are many nuances and different ways of doing it that deserve attention. The “wash sale” rule is the source of much confusion.
Best,
PoFReply
Leave a Comment
Medical Surveys that Pay
Passive Real Estate Investments
Physician Mortgage Lenders
Recommended Financial Advisors
CME Resources -- Get $$$ Back!
Recommended Services
Biz Retirement Account Specialists
Contract Negotiation and Review
Medical Surveys that PAY
Passive Real Estate Investments
Doctor Loan up to 100% Financing
Earn easy 1099 income with quick surveys for healthcare professionals with InCrowd
Register with All Global Circle and receive a bonus of up to $50
Related Articles
The Sunday Best (03/10/2024)
The Sunday Bestis a collection of articles I’ve curated from the furthest
Read More »
Navigating Health Care Options If You Plan to Retire Early
There’s been a lot of hype and media attention around pursuing and
Read More »
Die With Zero by Bill Perkins: A Book Review
Die With Zero by Bill Perkins: A Book Review Die with Zero
Read More »
Join Thousands of Doctors on the Path to FIRE
Get exclusive tips on how to reclaim control of your time and finances.
