Nontaxable Dividends

DEFINITION of Nontaxable Dividends

Nontaxable dividends are dividends from a mutual fund or some other regulated investment company that are not subject to taxes. These funds are frequently not taxed in light of the fact that they invest in municipal or other tax-exempt securities.

BREAKING DOWN Nontaxable Dividends

A mutual fund is an investment vehicle comprised of a pool of money collected from numerous investors. Mutual funds invest in securities, for example, stocks, bonds, money market instruments, and different assets. Investors receive two types of earnings from mutual fund shares: dividends and interest from the securities held in the fund portfolio, or investment income; and capital gains that outcome from the revenue driven sale of portfolio securities.

Investment income can be reinvested in the fund or paid in cash to the investor. One way or another, it is taxable as ordinary income, contingent upon the investor's marginal tax bracket.

Nontaxable Dividends

Not all dividends are subject to taxation, in any case. One common type of tax-exempt income is interest earned on municipal bonds, which are bonds issued by states and urban communities to raise funds for general operations or a specific project. At the point when a taxpayer makes interest income on municipal bonds issued in their state of residence, the profit is exempt from both federal and state taxes.

A mutual fund must basically invest its capital into tax-exempt investments for its dividends to be classified as nontaxable.

Municipal Bonds

Municipal bonds (or "munis" for short) are debt securities issued by states, urban communities, counties, and other government substances to fund everyday obligations and to finance capital projects like building schools, interstates, or sewer systems. By purchasing municipal bonds, you are in effect lending money to the bond issuer in exchange for a commitment of standard interest payments, for the most part semi-every year, and the return of the original investment, or "principal." A municipal bond's maturity date (the date when the issuer of the bond reimburses the principal) might be a very long time from here on out. Short-term bonds mature in one to three years, while long-term bonds will not mature for over a decade.

Generally, the interest on municipal bonds is exempt from federal income tax. The interest may likewise be exempt from state and nearby taxes assuming you dwell in the state where the bond is issued. Bond investors ordinarily look for a constant flow of income payments and, compared with stock investors, might be more gamble loath and more centered around safeguarding, as opposed to expanding, wealth. Given the tax benefits, the interest rate for municipal bonds is generally lower than on taxable fixed-income securities like corporate bonds.