C Corp Dividends: Taxation and Reporting Process
Understand the tax treatment and procedural steps for C Corp dividends, from the effects of double taxation to the formal reporting requirements.
A C corporation dividend is a distribution of company profits to its shareholders, representing a return on their investment. The decision to issue dividends rests with the company’s board of directors, who evaluate the firm’s financial health before authorizing a distribution. For investors, dividends are a way to share in a company’s success, while for the corporation, paying them can signal financial stability and attract potential investors. The amount each shareholder receives is proportional to the number of shares they own, and distributions are made in cash, additional stock, or other property.
The Taxation of C Corp Dividends
A defining characteristic of C corporation dividends is “double taxation,” where profits are taxed twice. First, the corporation pays federal income tax on its net income at a 21% flat rate, reported on Form 1120, U.S. Corporation Income Tax Return. After the corporation pays its taxes, the remaining profits can be distributed to shareholders as dividends.
When shareholders receive these dividends, they must then pay personal income tax on that amount. This second layer of taxation completes the double taxation process, as the corporation does not receive a tax deduction for dividends paid. The shareholder’s tax rate depends on whether the dividends are “qualified” or “non-qualified.”
Qualified dividends benefit from lower tax rates, which are the same as long-term capital gains rates: 0%, 15%, or 20%, depending on the shareholder’s taxable income and filing status. To be qualified, dividends must be paid by a U.S. or qualifying foreign corporation, and the shareholder must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
Non-qualified dividends do not meet these criteria and are taxed at the shareholder’s ordinary income tax rates, which can be as high as 37%. For example, if a corporation earns $100,000 in profit, it first pays $21,000 in corporate tax. If it distributes the remaining $79,000 as a qualified dividend to a shareholder in the 15% bracket, that individual would owe $11,850 in taxes.
Information and Decisions for Issuing Dividends
Before a C corporation can distribute dividends, it must confirm the company has sufficient Earnings and Profits (E&P). E&P is an accounting measure used to determine a corporation’s ability to pay dividends. Distributions are only considered taxable dividends to the extent they are paid from the corporation’s current or accumulated E&P.
Once E&P is confirmed, the Board of Directors must establish three distinct dates for the payment. The declaration date is when the board formally announces its intention to pay a dividend. The record date is the day the company finalizes the list of shareholders eligible to receive the payment. The payment date is when the funds are actually distributed.
The formal declaration of a dividend must be documented in a Board of Directors resolution. This resolution must specify the dividend amount per share, as well as the declaration, record, and payment dates. This documentation creates a legal obligation for the company to pay the declared dividend.
The Dividend Issuance and Reporting Process
On the payment date established in the board resolution, the corporation distributes funds to its shareholders. The corporation reports these distributions on its annual tax return, Form 1120, specifically on Schedule M-2. This schedule reconciles the changes in the corporation’s unappropriated retained earnings account for the tax year, and cash dividends paid are a component of this reconciliation.
The corporation also has a reporting responsibility to its shareholders and the Internal Revenue Service (IRS). For each shareholder who receives $10 or more in dividends, the corporation must issue Form 1099-DIV, Dividends and Distributions. This form details the total amount of dividends paid and specifies what portion is qualified versus non-qualified.
Copies of Form 1099-DIV must be sent to shareholders by January 31 of the following year. The form must also be filed with the IRS by February 28 for paper filings or March 31 for electronic filings.
Understanding Constructive Dividends
A constructive dividend is a benefit provided by a corporation to a shareholder that the IRS recharacterizes as a dividend, even though it was not formally declared. This concept is relevant for closely-held corporations where the lines between corporate and personal finances can blur.
The IRS may identify a constructive dividend when corporate funds are used to personally benefit a shareholder without a clear business purpose. Common examples include:
- The corporation paying for a shareholder’s personal expenses, such as personal travel.
- Providing rent-free use of corporate property.
- Making below-market-rate loans to a shareholder.
- Paying a salary that is considered excessive for the services provided.
- A bargain sale of corporate property to a shareholder for less than its fair market value.
The tax consequences can be significant. The payment is disallowed as a deductible business expense for the corporation, which increases its taxable income. For the shareholder, the value of the benefit is treated as taxable dividend income, subject to the same tax rates as a formal dividend. This recharacterization can lead to unexpected tax liabilities and potential penalties.