Distributions vs. Dividends: What’s the Difference?

Companies reward their owners by passing along profits, a process that differs depending on the business’s legal structure. While the terms are often used interchangeably in conversation, for tax and accounting purposes, their meanings are precise. The distinction between a “dividend” and a “distribution” has financial consequences for both the company and its owners, affecting how income is reported and taxed.

C Corporation Payouts as Dividends

A C corporation provides returns to its shareholders through payments known as dividends, which are drawn from the corporation’s retained earnings. This system leads to double taxation, where the corporation first pays tax on its profits, and shareholders then pay personal income tax on the dividends they receive from those after-tax profits.

The shareholder’s tax rate depends on whether the dividend is qualified or non-qualified. Qualified dividends are taxed at lower long-term capital gains rates of 0%, 15%, or 20%, depending on taxable income. To be qualified, dividends must be from a U.S. or qualifying foreign corporation, and the shareholder must meet a minimum stock holding period of more than 60 days.

Dividends that do not meet these criteria are non-qualified and are taxed at the shareholder’s regular income tax rate. At the end of the tax year, shareholders receive Form 1099-DIV, “Dividends and Distributions,” from the corporation. This form details the total dividends paid and specifies which portions are qualified and non-qualified for tax filing.

Pass-Through Entity Payouts as Distributions

Owners of pass-through entities like S corporations, limited liability companies (LLCs), and partnerships receive payments called distributions. The taxation of these entities avoids the double taxation of C corporations. Profits, losses, deductions, and credits are “passed through” to the owners, who report them on their personal tax returns and pay tax on their share of the profits, regardless of whether they receive a cash distribution.

A distribution is tied to the owner’s basis, which is their financial investment in the company. The basis increases with capital contributions and profits and decreases with losses and distributions. Because the profits have already been taxed at the personal level, a distribution is a tax-free return of the owner’s investment, as long as it does not exceed their basis.

If a distribution is larger than the owner’s basis, the excess amount is treated as a capital gain and is subject to capital gains tax. Owners track their basis and receive a Schedule K-1 at the end of the year. This form reports their share of the entity’s financial results and the total distributions they received.

Tax Reporting for Owners

The tax forms and reporting process differ for dividends and distributions. Owners must transfer the information from the forms they receive onto their Form 1040, U.S. Individual Income Tax Return.

For C corporation dividends, the necessary figures are on Form 1099-DIV. The total ordinary dividends are reported on Form 1040, and if the amount exceeds $1,500, the taxpayer must also file Schedule B, “Interest and Ordinary Dividends.” The qualified dividends figure is used to calculate tax at the lower capital gains rates.

For pass-through entities, reporting centers on Schedule K-1. The distribution amount itself is not reported as income but is used to reduce the owner’s basis. The owner’s share of the entity’s income or loss is reported on Schedule E, “Supplemental Income and Loss.” If a distribution exceeds the owner’s basis, the excess is reported as a capital gain on Schedule D, “Capital Gains and Losses.”