Are Dividends Considered Capital Gains?

While dividends and capital gains are distinct financial concepts, the overlap in their tax treatment causes common confusion. A dividend represents a distribution of a company’s earnings to its shareholders. A capital gain, on the other hand, is the profit generated from selling a capital asset, such as a stock, for more than its original purchase price. The tax rules for certain types of dividends and capital gains are similar, which often leads to them being discussed together.

Defining Dividends and Their Taxation

A dividend is a payment made by a corporation to its shareholders, usually out of its profits. For tax purposes, dividends fall into two main categories: qualified and non-qualified, also known as ordinary dividends. Non-qualified dividends are taxed at an individual’s regular income tax rate, the same rates that apply to wages.

For a dividend to be “qualified,” it must meet specific criteria, including being paid by a U.S. or qualified foreign corporation. An investor must also have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

Qualified dividends are taxed at the lower long-term capital gains tax rates, which are 0%, 15%, or 20%, depending on the taxpayer’s taxable income. Ordinary dividends are taxed according to the standard federal income tax brackets, which can be substantially higher.

Defining Capital Gains and Their Taxation

A capital gain is the profit realized from the sale of a capital asset. Capital assets include most property owned for personal use or investment, such as stocks, bonds, and real estate. The gain is calculated as the sale price minus the asset’s adjusted basis, and the tax treatment depends on how long the asset was held before being sold.

The holding period separates capital gains into two classifications: short-term and long-term. A short-term capital gain results from selling an asset owned for one year or less. These gains are taxed at the same rates as an individual’s ordinary income.

A long-term capital gain arises from the sale of an asset held for more than one year. These gains receive preferential tax treatment, with rates set at 0%, 15%, or 20%, based on the taxpayer’s filing status and taxable income. This structure is designed to encourage long-term investment.

Comparing Tax Rates and Treatment

The primary reason dividends and capital gains are often linked is their shared tax rate structure. As established, both qualified dividends and long-term capital gains are taxed at the same preferential federal rates. Similarly, non-qualified dividends and short-term capital gains are both taxed at an individual’s higher ordinary income tax rates.

Despite the similar tax rates, their origins are fundamentally different. Dividends are distributions of a company’s earnings, while capital gains are generated only when an investor sells an asset for a profit. The holding period requirements that determine the tax treatment also differ between a qualified dividend and a long-term capital gain.

Reporting on Your Tax Return

Dividend and capital gain income are reported using information from forms provided by financial institutions. Investors receive Form 1099-DIV, which details dividend income. Box 1a of this form shows total ordinary dividends, while Box 1b specifies the qualified portion. Some funds may also pay capital gain distributions, reported in Box 2a, which are taxed as long-term capital gains.

Proceeds from the sale of assets are reported on Form 1099-B. Taxpayers use this information to complete Form 8949, which then feeds into Schedule D (Capital Gains and Losses). Dividend income from Form 1099-DIV is reported on Schedule B (Interest and Ordinary Dividends).

Higher-income taxpayers may be subject to an additional tax on both dividend income and net capital gains. The Net Investment Income Tax (NIIT) is a 3.8% tax that applies if modified adjusted gross income exceeds certain thresholds, such as $200,000 for single filers and $250,000 for those married filing jointly. This tax is calculated on Form 8960.