Understanding Dividends

Dividends are a common form of income for investors, but understanding how they are taxed is crucial for managing your finances effectively. Here's a quick overview of what you need to know:

What Are Dividends? Understanding Dividends

Dividends are distributions of property a corporation may pay you if you own stock in that corporation. Most dividends are paid in cash, but they can also be paid as stock or other property. You might also receive dividends through partnerships, estates, trusts, subchapter S corporations, or associations taxable as corporations.

Types of Dividends

Dividends can be classified into two main types:

1. Ordinary Dividends: These are the most common type and are taxable as ordinary income. These dividends are payments made by a corporation to its shareholders from its earnings or profits. These dividends are considered ordinary income by the IRS and are subject to standard income tax rates. They are typically paid out in cash and are often distributed on a regular schedule, such as quarterly or annually.

2. Qualified Dividends: These meet specific criteria and are taxed at the lower capital gains tax rates.

   To be considered a qualified dividend, the dividend must meet certain criteria set by the IRS:

   1. The dividend must be paid by a U.S. corporation or a qualified foreign corporation.

   2. The investor must hold the stock for a specific minimum period, generally more than 60 days within the 121-day period that begins 60 days before the ex-dividend date.

Reporting Dividends

You should receive a Form 1099-DIV from each payer for distributions of at least $10. If you're a partner in a partnership or a beneficiary of an estate or trust, you may need to report your share of any dividends received by the entity, even if they are not paid out to you.

Return of Capital

Not all distributions are dividends. A return of capital is a return of some or all of your investment in the stock of the company. This reduces the adjusted cost basis of your stock. Once the adjusted cost basis is reduced to zero, any further non-dividend distribution is a taxable capital gain.

Capital Gain Distributions

Regulated investment companies (RICs) and real estate investment trusts (REITs) may pay capital gain distributions, which are always reported as long-term capital gains.

Additional Considerations

• Ensure your Form 1099-DIV breaks down the distribution into various categories. If it doesn't, contact the payer.

• Provide your correct Social Security number to the payer to avoid penalties and backup withholding.

• If you receive over $1,500 of taxable ordinary dividends, report these on Schedule B (Form 1040)

Conclusion

Understanding the different types of dividends and how they are taxed can help you manage your investments more effectively. Always keep accurate records and consult with a tax professional if you have any questions.

See Also: Topic no. 404, Dividends

Understanding Dividends