How a Corporation Pays Dividends to Its Shareholders

A dividend is a distribution of a company’s accumulated profits to its shareholders, serving as a return on their investment. The decision to issue a dividend and its amount is made by the company’s board of directors, often signaling confidence in the company’s financial health. Not all companies pay dividends. Younger, high-growth companies frequently reinvest profits to fund expansion, while more mature and stable companies are more likely to distribute earnings. These payments can provide a steady income stream for investors and are often seen as an indicator of a company’s stability.

The Corporate Process for Issuing Dividends

A dividend payment is formally declared during a board meeting and is paid from the company’s retained earnings, which are the cumulative profits not previously paid out. A corporation cannot legally pay a dividend if it lacks sufficient retained earnings or if the payment would cause insolvency. The process unfolds over three important dates.

The declaration date is the day the board officially announces the dividend, which creates a legal liability for the company to pay. The announcement will specify the dividend amount per share and the other dates in the process.

The next date is the date of record. To receive the dividend, an investor must be registered as a shareholder on the company’s books on this specific date. This ensures payment is made to the correct individuals, as an investor who buys shares after the date of record is not entitled to that dividend.

Finally, the payment date is when the dividend is distributed to eligible shareholders, often as direct cash deposits into their brokerage accounts. The time between the record and payment dates allows the company to finalize its shareholder list and process the payments.

Types of Dividend Distributions

While cash is the most common form, corporations can distribute value to shareholders in several ways.

• Cash dividends are straightforward payments transferred electronically to a shareholder’s account. This method is favored for its simplicity and for providing investors with immediate income, with the amount expressed on a per-share basis.
• Stock dividends are distributions of additional shares of the company’s own stock instead of cash. This allows a company to reward investors without depleting its cash reserves, though it increases the total number of shares outstanding, which can dilute the value of each share.
• Property dividends are distributions of assets other than cash or company stock, such as inventory or shares of another company. This type of distribution is rare because of the complexities involved in valuing and distributing the assets.
• A return of capital is different from a dividend because it is not a distribution of profits. Instead, it is a payment from the company’s paid-in capital that reduces the shareholder’s cost basis in the stock rather than being treated as income.

Tax Treatment of Dividends for Shareholders

The way a dividend is taxed depends on whether it is classified as “qualified” or “non-qualified,” a distinction determined by IRS criteria. This classification focuses on the nature of the paying corporation and how long the shareholder has owned the stock.

Qualified dividends are taxed at the more favorable long-term capital gains rates, which are 0%, 15%, or 20%, depending on the shareholder’s taxable income. For a dividend to be qualified, it must be paid by a U.S. corporation or a qualified foreign corporation. The shareholder must also meet a holding period requirement, having held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

Any dividend that does not meet these criteria is considered a non-qualified, or ordinary, dividend. These distributions are taxed at the shareholder’s regular ordinary income tax rates, which are higher than the long-term capital gains rates. For instance, a shareholder in the 24% marginal tax bracket would pay 24% tax on an ordinary dividend, whereas the tax rate on a qualified dividend would be 15%.

Understanding Form 1099-DIV

Shareholders receive Form 1099-DIV, “Dividends and Distributions,” from the brokerage firm or corporation that paid them dividends. This form is an important document for tax preparation, as it reports the total dividend income received and breaks it down into different tax categories. The information on this form is also reported directly to the IRS.

Box 1a shows the total amount of ordinary dividends received, which is the starting point for reporting dividend income. Box 1b specifies the portion of the total in Box 1a that is considered a qualified dividend. This is the figure eligible for the lower long-term capital gains tax rates and is a subset of the total, not an additional amount.

Another box, 2a, reports total capital gain distributions. These are paid by mutual funds or real estate investment trusts (REITs) and are also taxed at long-term capital gains rates. The information from these boxes is used to complete a personal tax return, often being transferred to Schedule B and Schedule D.