Do I still pay taxes on Dividends that's set to be reinvested for ETFs & Index Funds?

So I just started investing more seriously a few months ago and set up a few positions in both ETFs and index funds. Everything is going well, but tax season is coming up and I realized I don't understand how taxes work with dividends that get automatically reinvested. I have my account set to DRIP (dividend reinvestment) for all my holdings - basically every time I get a dividend payment it automatically buys more shares instead of giving me the cash. Since I never actually "received" this money in my bank account, do I still have to pay taxes on it? Or does the reinvestment aspect change anything? For context, this is a regular taxable brokerage account, not a Roth IRA or 401k or anything like that. I'm holding VTI, VXUS, and a couple of dividend-focused ETFs. Total dividends for the year were around $780 if that matters. Any help would be super appreciated! I'm trying to get my tax stuff organized early this year instead of panicking last minute lol.

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20 comments

CosmicCadet

•8M

Yes, you do still need to pay taxes on those dividends even though they're being automatically reinvested. The IRS considers those dividends as income to you the moment they're paid out, regardless of whether you take them as cash or reinvest them. Your brokerage will send you a Form 1099-DIV in January/February that shows all your dividend income for the year. You'll report this on your tax return and potentially owe taxes on it depending on your overall tax situation. Also good to know: qualified dividends (which many ETFs distribute) are taxed at the lower capital gains tax rates rather than as ordinary income, which is more favorable. Regular dividends are taxed as ordinary income. Your 1099-DIV will break this down for you.

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CosmicCadet

•8M

That's a good question. This applies to taxable accounts like the one the original poster mentioned. For tax-advantaged accounts like a Roth IRA, the dividends are not taxable when they're paid or reinvested inside the account. With a Roth, you've already paid taxes on the money you contributed, so qualified withdrawals (including those dividends) will be tax-free in retirement. For traditional IRAs and 401(k)s, dividends also grow tax-deferred inside the account, meaning you don't pay taxes on them until you withdraw from the account in retirement.

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Diego Mendoza

•8M

I was in the exact same situation last year and found this incredible tool that helped me figure out exactly what dividends were taxable and even calculated my potential tax liability. I used https://taxr.ai and uploaded my brokerage statements, and it automatically identified all the dividend distributions, whether they were qualified or not, and showed me what I'd likely owe. Honestly saved me hours of manual calculations and prevented me from missing some dividends that my brokerage had categorized weirdly. It even explained why certain dividends from my ETFs were considered "return of capital" and weren't immediately taxable (but would affect my cost basis).

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Diego Mendoza

•8M

It works with statements from most brokerages, including smaller ones. The system is designed to recognize and parse different statement formats, and it's continuously improving. If it encounters a format it's not familiar with, it will still extract the information but might ask you to verify certain items. The accuracy was impressive compared to what I actually owed. In my case, it was within about $7 of my final tax liability for dividends. The tool correctly identified which dividends were qualified vs. non-qualified and properly accounted for foreign tax credits from my international ETFs, which I would have missed otherwise. It's not just calculating based on gross dividend amounts - it actually understands the tax treatment of different distribution types.

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Anastasia Popova

•8M

Just wanted to update after trying taxr.ai from the previous comment. It actually worked great with my smaller brokerage! Uploaded my statements and it parsed all my dividend info correctly, even identifying some distributions that weren't actually dividends but return of capital. Saved me from overpaying on taxes. What really surprised me is it showed me some foreign tax credits I could claim from my international ETFs that I had no idea about! Apparently I've been overpaying for the last two years. Definitely using this for my 2025 filing.

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Zara Shah

•8M

If you're having trouble getting good information about your specific dividend tax situation, I'd recommend calling the IRS directly. I know everyone dreads that, but I used https://claimyr.com to get through to an agent in under 15 minutes instead of waiting on hold forever. You can see how it works here: https://youtu.be/_kiP6q8DX5c They answered all my questions about how dividends from different fund types are taxed, especially for some complicated MLP distributions I had. The agent was actually super helpful and gave me specifics about my situation rather than just generic advice you find online.

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Zara Shah

•8M

They don't just call for you - they use a system that navigates the IRS phone tree and waits on hold in your place. When they reach a live agent, you get a call connecting you directly to that agent. It's like having someone wait in a physical line for you. It works by continuously calling and navigating the IRS system until they get through, which can sometimes take their system multiple attempts - but you don't have to deal with any of that. You just get the call when an agent is actually on the line. I was skeptical too until I tried it. The time savings was absolutely worth it for me, especially during tax season when hold times can be 2+ hours.

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Sean Flanagan

•8M

Ok I have to admit I was wrong. After bitching about that Claimyr service I decided to try it anyway out of desperation because I had some complicated questions about ETF dividends from closed funds. Got connected to an IRS agent in about 20 minutes when my last attempt at calling them directly had me on hold for over 2 hours before I gave up. The agent walked me through exactly how to report some weird dividend situations I had with REITs and MLPs in my ETFs. Turns out I've been doing it wrong for years! Some of those distributions weren't even dividends but return of capital which have completely different tax treatment. Probably saved me more in potential penalties than the service cost.

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Luca Ferrari

•8M

One thing to keep in mind with reinvested dividends is that they increase your cost basis in the investment, which will help reduce capital gains taxes when you eventually sell. For example, if you initially invested $10,000 in an ETF and reinvested $2,000 in dividends over the years (which you paid taxes on when they were distributed), your cost basis would be $12,000. If you later sell for $15,000, you'd only pay capital gains tax on $3,000 ($15,000 - $12,000) rather than $5,000. Make sure your brokerage is tracking this correctly! Some don't automatically adjust cost basis for reinvested dividends if you've held the investment for many years.

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Luca Ferrari

•8M

You can check by logging into your brokerage account and looking at the "cost basis" information for your holdings. Look for a section that might be called "account details," "positions," or "tax lots." Good brokerages will show your original purchase plus separate lots for each reinvestment with their own purchase dates and prices. If you don't see this level of detail, or if the cost basis looks suspiciously close to your original investment amount despite years of reinvesting, you might need to contact your brokerage or start tracking it manually. This is especially important for investments you purchased before 2012, as brokerages weren't required to track cost basis before then.

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Myles Regis

•4M

Generally the credit is better because it's a dollar-for-dollar reduction in your tax liability, while a deduction just reduces your taxable income. However, there's a limit on the foreign tax credit - it can't exceed your US tax liability on the foreign income. For most people with international ETFs, the credit amount is small enough that you'd take the full credit. But if you're in a very low tax bracket, sometimes the deduction might work out better. Your tax software should calculate both and recommend the better option for your situation.

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Kirsuktow DarkBlade

•2M

Great question! I was confused about this exact same thing when I started investing. Yes, you absolutely still owe taxes on those reinvested dividends - the IRS treats them as if you received the cash and then immediately used it to buy more shares. Since you mentioned you're holding VTI and VXUS, most of those dividends will likely be "qualified dividends" which get the favorable capital gains tax treatment (0%, 15%, or 20% depending on your income level) rather than being taxed as ordinary income. Your brokerage will send you a 1099-DIV that breaks down qualified vs. non-qualified dividends. One silver lining - those reinvested dividends do increase your cost basis in the funds, so when you eventually sell, you'll have less capital gains to pay taxes on since your purchase price will include all those reinvestments you already paid taxes on. $780 in dividends isn't too bad for your first year! Just make sure to save some cash for the tax bill if you haven't been setting aside money for taxes on your investment gains.

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