I buy stock for $100 and it generates a $3.00 dividend (which I claim as income) the first year. I then sell the stock @ $105. What income do I have to claim for taxes?

[vinani77]

Something I've never understood about our tax law on the sale of securities--can you tell me if my understanding is correct, because it always felt like I was being taxed double (2X) for the same income. I know that mutual funds are treated differently--my question relates strictly to stock. 

Let's say I buy a share of stock for $100.00 and it generates a $3.00 dividend (which I claim as income) the first year. I then decide to sell the stock in year 2 (before any dividends are declared) and it's value is now $105.00. As far as the gov't is concerned, I earned $5.00 from my investment, which I must claim as income. But I've already declared $3.00 in dividend income, so in my mind, I should only be taxed $2.00 ($2.00 in appreciation + $3.00 in previously-declared dividend income). I know this is not the case, and I have to declare the total appreciation ($5.00) as income, but I feel like I'm paying tax twice on the $3.00 dividend income. Am I thinking this the right way--is this one of the "flaws" in our tax code? 

[Howard1948 · Accepted solution]

Call it a flaw, call it a discombobulated exacerbation, call it what you will, your analysis of how it works is correct.

As to whether it is double taxation, look at any publicly-traded stock and how it is quoted on the "ex-dividend" date.  The ex-dividend date is the date on which the stock first trades without the upcoming dividend attached to it.  If you buy the stock on the ex-dividend date or thereafter, you do not get the dividend.  You will note that the stock begins trading on the ex-dividend date by the prior day's close LESS the dividend.  So if your stock that you bought at $100 is at $101 on the ex-dividend date, the opening  price on the next day, the ex-dividend date, would be $98 ($101 prior day close less the $3 dividend).  So if the stock then rises to $105, you actually own a stock that rose $7, but, as you noted, your basis is still $100 and your realized gain on sale is only $5.

[VolvoGirl]

Are you taking the dividend in cash or do you leave it in so it buys more shares?  If your reinvest it (DRIP) then you need to add the dividend amount to your cost basis so you don't pay tax on it twice.