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Dividends


What is Dividend Income?

  • Dividends are distributions of money, stock, or other property, paid to you by a corporation. Dividends are also received from a partnership, estate, trust, or an association taxed as a corporation.
  • Many kinds of dividends you receive are actually interest income, not dividend income. This includes dividends paid on deposits or share accounts in cooperative banks, credit unions, domestic savings and loan institutions, federal savings and loan associations, and mutual savings banks. Dividends that are actually interest are reported on Schedule B.
  • For most types of dividends, you should receive a Form 1099 DIV from the payer of the dividends. Even if you do not receive this form, it is still your responsibility to report the income on your tax return.

Source Determines Taxability

The source of distribution dictates the character. The following four sources exist:

  • Earnings & Profits/Current = Distribute by Current Year End
  • Earnings & Profits/Accumulated = Distribution Date
  • Return of Capital = No Earnings & Profits
  • Capital Gain Distributions = No Earnings & Profits/No Basis

Three Categories of Dividends

Taxable Dividends

All dividends that represent distributions of a corporation’s earnings and profits (similar to retained earnings) are included in gross income.

  • Taxable Amount to Shareholder:

    • Cash = Amount Received
    • Property = Fair Market Value

  • Special (Lower Tax Rate)

    • Qualified Dividends Holding Period

      The stock must be held for more than 60 days during the 120-day period that begins 60 days before the ex-dividend rate (the date on which a purchased share no longer is entitled to any recently declared dividends).

    • Disqualified Dividends

      • Employer stock held by an ESOP
      • Amounts taken into account as investment income (for purposes of the limitation on investment expenses)
      • Short sale positions
      • Certain foreign corporations
      • Dividends paid by credit unions, mutual savings banks, building and loan associations, mutual insurance companies, and farmer’s cooperatives.

    • Tax Rates (2012)

      • 15% – Most Taxpayers
      • 0% – Low income taxpayers (those in the 10% or 15% ordinary income tax bracket)

Tax-free Distributions

The following items are exempt from gross income:

  • Return of Capital

    Return of capital exists when a company distributes funds but has no earnings and profits. The taxpayer will simply reduce (but not below zero) his/her basis in common stock held.

  • Stock Split

    When a stock split occurs, the shareholder will allocate the original basis over the total number of shares held after the split.

  • Stock Dividend

    Unless the shareholder has the option to receive cash or other Property (at FMV), the basis of shares after distribution depends on the type of stock received.

    • Same stock – original basis is divided by total shares
    • Different stock – original basis is allocated based on the relative FMV of the different stock

  • Life-Insurance Dividend

    Dividends caused by ownership of insurance with a mutual company (premium return).

Capital Gain Distribution

Distributions by a corporation that has no earnings and profits, and for which the shareholder has recovered his or her entire basis, are treated as taxable gross income.


Forms

Form 1099 DIV
Schedule B – Interest & Dividends
Publication 550

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