VOO Dividends--How to avoid double tax when wanting to spend them? (2024)

I have a question regarding VOO and how the dividends are taxed in my taxable account.

I know the dividends are reinvested automatically in the fund. So if the yield is 2.0% annually, it's not like the investor is getting 2.0% more shares annually like a stock DRIP plan, but instead the fund or shares would be worth 2% per year more, all else equal.

However, say I put in 10K into VOO and it keeps rising to being worth 100K in several years say year 2035 (optimistic but for illustration), and most of the rise to 100K from 10K would be from capital appreciation not the dividends it received since it initially pays out just $200\yr. Then when it is 100K and getting 2% in annual dividend yield I want to spend the dividends or the $2000/year to live off of. In 2035, the fund would automatically reinvest the $2k/year dividend and I would pay tax on it but then to actually get $2K cash, or the equivalent of the dividend to the fund (that the fund auto re invested), I believe I would have to just sell $2K worth of shares of the fund to actually have cash to live off of if i want to live off my dividends. But then that would trigger capital gains since much of the fund was bought at priced 10x lower than current price of my total capital rose from 10K to 100K.

When the dividend is a to reinvested in fund, is there a way it is tracked separately at higet cost basis so if you sold the shares to capture dividend it is not at lower cost basis of original purchsse?

So basically if I spend the $2K by selling $2K in shares in 2035, that $2K would face capital gain tax since it had big unrealized capital gains, but then the 2K reinvested would also pay tax so I'm seemingly paying double tax on the same $2K compared of I just had say IVV or VTI that just paid the 2% dividend or $2000 in 2035 in cash that is taxed and then I can spend.

Am I missing something here?

Is there no way to parse dividend reinvested from initial position when selling VOO?

I think you are missing something ... have you ever filled out your own tax return when you have received dividends or sold shares?

The main point to know is that Return of capital is tax-free., so your capital is taxed only once (or maybe you are in a low enough tax income situation that it is not even taxed the first time).

I'll try to come up with a good example if you request it or maybe someone else will chime in.

SovereignInvestor wrote: ↑Wed Jan 16, 2019 6:40 amI have a question regarding VOO and how the dividends are taxed in my taxable account.

I know the dividends are reinvested automatically in the fund. So if the yield is 2.0% annually, it's not like the investor is getting 2.0% more shares annually like a stock DRIP plan, but instead the fund or shares would be worth 2% per year more, all else equal.

You do not need to reinvest dividends in VOO - you can take them as cash or reinvest them in a different fund (2 step process in new brokerage accounts).

When a fund issues a dividend and you choose to reinvest the dividend in the fund, you do get more shares. But each share is worth less, such that your total value is the same before and after the dividend is reinvested. But you pay tax on the dividend, which is the tax drag of holding a fund in a taxable account.

Here's an example:

1. Buy $10,000 of VOO with money from your job.

2. Get $200 of dividends. The $200 is income on your taxes. Buy $200 more of VOO. You have now paid $10200 for your shares of VOO.

3. Get $204 of dividends. The $204 is income on your taxes. Buy $204 more of VOO. You have now paid $10404 for your shares of VOO.

4. Get $208 of dividends. The $208 is income on your taxes. Buy $208 more of VOO. Your capital invested in VOO is $10612.

5. Sell your VOO. Your cost basis is $10612, so you don't pay any taxes on your return of capital of $10612.

Or instead of buying shares of VOO with the VOO dividend, you buy sushi lunches with the money. You have not paid double tax on the dividends.

Then you sell all your shares of VOO. Your cost basis is $10,000 so your return of capital is $10,000 and that $10,000 of your sale proceeds is not taxed.

Livesoft.

I understand that but I never want to sell the initial position. I would live to hold forever and eventually spend dividends and only pay tax on them.

What you suggest means I only get the benefit back when I sell the whole position which I don't want to do ever

Growth seeker--

So the VOO Dividends don't automatically go back into the fund? I thought the appeal of VOO I've read about is that it reinvested dividends to avoid friction. Or did that mean they just offer a free DRIP in case the broker would charge? So basically VOO is like SPY or VTI...they pay cash dividend and you can choose to do whatever?

For some reason I thought VOO was different

SovereignInvestor wrote: ↑Wed Jan 16, 2019 7:14 am
So the VOO Dividends don't automatically go back into the fund? I thought the appeal of VOO I've read about is that it reinvested dividends to avoid friction. Or did that mean they just offer a free DRIP in case the broker would charge? So basically VOO is like SPY or VTI...they pay cash dividend and you can choose to do whatever?

For some reason I thought VOO was different

http://lmgtfy.com/?q=Voo+dividend

SovereignInvestor wrote: ↑Wed Jan 16, 2019 7:14 amLivesoft.

I understand that but I never want to sell the initial position. I would live to hold forever and eventually spend dividends and only pay tax on them.

What you suggest means I only get the benefit back when I sell the whole position which I don't want to do ever

No, that is not what I suggested.

If you take the dividends in cash and spend them, then that's a benefit.

If you take the dividends and buy more shares of VOO (reinvest them or have them reinvested -- it's the same)), then later you can sell ONLY the shares purchased with dividends and not the original shares that you bought. The money from selling only the shares purchased with dividends is a benefit. There is no tax on the return of capital of the shares bought with dividends. That is, the shares bought with dividends have a cost basis. In my first example, the cost basis is $200 + $204 + $208 = $612. You don't pay tax on that $612 when you sell the shares bought with the dividends.

Now I am writing about taxes for a US citizen living in the USA because you wrote about VOO. I am not writing about some of the fancy shares available to European and other foreign investors that have so-called accumulating shares.

Also if you look closely you'll find about four times per year a post titled "why did my fund lose value today when the market was up?" The answer always is that dividends and capital gains distributions were paid out and the fund's net asset value was adjusted (or the ETF's share price). Funds accumulate dividends and capital gains continuously that can sit in the fund as cash assets. These days some funds keep the cash invested in a liquid ETF to stay fully invested. NAV is assets minus liabilities divided by outstanding shares. They return some cash to the investor periodically (typically quarterly for equity funds, monthly for bond funds). In short your unrealized gains drop when a cash distribution is made.

If you reinvest dividends your cost basis goes up by the purchase cost of those shares. You might pay tax in the future when you sell on the appreciation you get from those additional shares but you do not owe tax again on the money you reinvested.

There is no double taxation.

Okay I see that it is paid in cash. I'm sorry if it was obvious. I just recall from initial research in VTO vs VOO someone mentioned VOO auto reinvesting.

I mistakenly thought the fund retained what would be dividends and it makes thE fund appreciate faster but no way of parsing dividend versus initial capital for tax reasons....from responses that was wrong..that's not what happens.

But as everyone states they pay the dividend in cash and then we can do whatever we want. And if we reinvested cash for more shares then we can sell those higher cost basis shares and only pay tax on dividend essentially.

Thank you for help everyone.

2 points-

*You pay taxes on dividends no matter what you do with them in your taxable account
*If you take them in cash you are making a withdrawal from the fund, around 2% currently

GrowthSeeker wrote: ↑Wed Jan 16, 2019 9:15 amOne feature of VOO as well as most Vanguard ETFs is the the ETF is a special share class of the mutual fund (only Vanguard because it’s patented, not sure for how much longer). That somehow gives Vanguard an extra tool to manipulate so the fund (and I guess the ETF) generates much less capital gains than non-Vanguard funds.
Maybe it was this feature (which I incompletely understand) that you had heard about??? Maybe the double tax idea was 1) dividends, and 2) capital gains. ???

This is more of a benefit of the mutual fund and is mostly irrelevant for the ETF. Index fund ETFs almost never distribute capital gains. Mutual funds on the other hand do so if wanting mutual funds using Vanguard's can be a slight tax benefit.

livesoft wrote: ↑Wed Jan 16, 2019 7:05 amHere's an example:

1. Buy $10,000 of VOO with money from your job.

2. Get $200 of dividends. The $200 is income on your taxes. Buy $200 more of VOO. You have now paid $10200 for your shares of VOO.

3. Get $204 of dividends. The $204 is income on your taxes. Buy $204 more of VOO. You have now paid $10404 for your shares of VOO.

4. Get $208 of dividends. The $208 is income on your taxes. Buy $208 more of VOO. Your capital invested in VOO is $10612.

5. Sell your VOO. Your cost basis is $10612, so you don't pay any taxes on your return of capital of $10612.

Thanks for the explanation about double taxation of dividends. I was wondering about this myself. Would you need to take the cash from the dividends out of the account in order to make this work or could you just keep track of the cash dividends being used to purchase more shares as you reinvest dividends?

DB2 wrote: ↑Fri Jan 25, 2019 1:10 pmSo, to make sure I am following: you only get taxed once on a capital gain investment (whether a share or dividend, or that particular dividend reinvestment). There is no double taxing.

That is exactly right except for one minor instance which I will let folks ponder about.

Essentially return of capital is tax-free.

DB2 wrote: ↑Fri Jan 25, 2019 1:10 pmSo, to make sure I am following: you only get taxed once on a capital gain investment (whether a share or dividend, or that particular dividend reinvestment). There is no double taxing.

Correct.

People get tripped up on the "automatic" and "reinvesting" as somehow different from "buying". But let's imagine a land far far away where there is internet. And no such thing as automatic reinvestments.

You own an investment at Vanguard and it pays dividends. The dividends get sent to you via US Mail. You open the mailbox and see a dividend check for $200. What a coincidence, you owe your landlord $200 so you sign the check over to her. You'll pay taxes at the end of the year on this dividend. But what if on the same day you realize that because use used that dividend check to pay your landlord, you have an extra $200 in your checking account that you could invest? So you write out a $200 check payable to Vanguard and mail it in with instructions to buy more of that particular investment. Now you have a new lot of $200 in addition to what you previously owed. One day, when you sell those shares, you may owe capital gains tax on the appreciation (if any). The dividends get taxed as dividend and gains get taxed as gains.

The only difference with automatic investing of dividends is that you've instructed Vanguard to just keep the dividend and apply it to new shares in that investment. It's no different, tax wise, than if they mailed you a check and you later sent them a new one (apart from there being no delay between the dividend being paid and new shares being bought). Tax wise, it all works out the same.