Are Reinvested Dividends Taxed Twice?

A common question among investors is whether they are taxed twice on dividends they choose to reinvest. The short answer is no. The confusion stems from the fact that two distinct taxable events can occur. The first is the taxation of the dividend as income in the year it is paid, and the second happens only when the shares purchased with that dividend are sold. Because each event is taxed independently, this process is not a form of double taxation.

The Initial Tax on Dividend Income

The Internal Revenue Service (IRS) views dividends as income for the year they are distributed to a shareholder. This is true whether the investor receives the dividend as a cash payment or automatically uses it to purchase more shares through a dividend reinvestment plan (DRIP). The value of the dividend is considered received and is therefore subject to income tax. Your brokerage firm will report this income to you and the IRS on Form 1099-DIV, “Dividends and Distributions.”

The tax rate applied to this dividend income depends on whether the dividends are classified as qualified or non-qualified. Non-qualified dividends are taxed at the investor’s regular ordinary income tax rates, which for 2025 can range from 10% to 37%. Qualified dividends receive more favorable tax treatment and are taxed at long-term capital gains rates of 0%, 15%, or 20%, depending on the investor’s taxable income and filing status.

To be considered “qualified,” dividends must be paid by a U.S. corporation or a qualified foreign corporation, and the investor must meet a specific holding period requirement. You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Your Form 1099-DIV will separately list total ordinary dividends and the portion that is qualified.

Understanding Cost Basis for Reinvested Dividends

The mechanism that prevents double taxation on reinvested dividends is the adjustment to your investment’s cost basis. Cost basis is the total amount you have spent to acquire an asset, including commissions and fees. When you receive a dividend and it is taxed as income, reinvesting that dividend increases your cost basis in the investment. This ensures that you get credit for the after-tax money you put back into the holding.

Imagine you purchase 50 shares of a company for $10 each, for a total initial investment of $500. Your initial cost basis is $500. Later, the company pays a $1 per share dividend, totaling $50. You will pay income tax on this $50 in the year you receive it. If you reinvest that $50 and it buys you five additional shares at the same $10 price, your total holding becomes 55 shares.

The new basis is your original $500 investment plus the $50 reinvested dividend, for a new total of $550. This adjusted basis of $550 for your 55 shares reflects that the $50 used for the purchase has already been subjected to income tax. Keeping detailed records of each reinvestment—the date, the amount, and the number of shares purchased—is important for accurately tracking your adjusted cost basis over time.

Calculating Capital Gains Upon Sale

The second taxable event occurs when you decide to sell your shares. The tax you pay at this point is not on the entire value of the sale, but only on the capital gain. A capital gain is the difference between the sale price of your asset and your adjusted cost basis, so a higher cost basis directly reduces your taxable gain.

Continuing the previous example, you hold 55 shares with an adjusted cost basis of $550. A few years later, you sell all 55 shares for $15 each, for total proceeds of $825. To calculate your taxable gain, you subtract your adjusted cost basis from the sale proceeds: $825 (sale price) – $550 (adjusted cost basis) = $275 (capital gain). You will only pay capital gains tax on the $275 profit.

The tax rate on this gain depends on how long you held the shares. If you held the shares for one year or less before selling, the profit is a short-term capital gain, taxed at your ordinary income tax rates. If you held the shares for more than one year, it is a long-term capital gain, taxed at the more favorable 0%, 15%, or 20% rates.

Reporting to the IRS

Properly reporting these events to the IRS requires careful record-keeping. The dividend income you receive during the year, whether taken as cash or reinvested, is reported on your Form 1040. If your total dividend income is over $1,500, you must also file Schedule B, “Interest and Ordinary Dividends,” to list the source of each dividend payment.

When you sell your shares, the transaction is reported on Form 8949, “Sales and Other Dispositions of Capital Assets.” For each sale, you will report the proceeds, the date you acquired the shares, the date you sold them, and your cost basis. The proceeds are reported to you by your broker on Form 1099-B, but it is your responsibility to provide the correct adjusted cost basis, which includes all your reinvested dividends.

The gain or loss calculated on Form 8949 is then summarized on Schedule D, “Capital Gains and Losses,” which is attached to your Form 1040. While brokers are required to report cost basis on Form 1099-B for shares purchased since 2011, they may not have records for older shares or capture every adjustment. Maintaining your own detailed records of all purchases, including those made through dividend reinvestment, is the best way to ensure you accurately report your cost basis and avoid overpaying tax.