What Are Common Stock Dividends and How Do They Work?

Common stock dividends represent a portion of a company’s earnings distributed to its shareholders. While not all companies pay dividends, those that do typically aim to provide a regular income stream to their common stockholders.

Understanding Common Stock Dividends

A common stock dividend is a payment from a company’s accumulated profits to its common stock owners. Companies are not obligated to pay dividends to common stockholders; these distributions are discretionary. The decision to issue a dividend, and its amount, rests with the company’s board of directors, who consider the firm’s financial health, future investment needs, and overall earnings performance.

Common stockholders typically receive dividends after preferred shareholders, who have a higher claim on a company’s earnings and assets in the event of liquidation. Common stock ownership often comes with voting rights, allowing shareholders to influence corporate governance, and offers the potential for greater capital appreciation if the company’s value increases significantly. Companies with a history of consistent dividends are often considered “dividend stocks,” appealing to investors seeking regular income. Conversely, “growth stocks” are typically from companies that reinvest all their earnings back into the business to fuel expansion, foregoing dividend payments in favor of potential future capital gains.

Types of Common Stock Dividends

Common stock dividends can be distributed in various forms. The most common type is a cash dividend, where the company directly pays shareholders a specified amount of money per share they own. For instance, if a company declares a $0.50 per share cash dividend, an investor owning 100 shares would receive $50.

Another form is a stock dividend, which involves distributing additional shares of the company’s stock instead of cash. This increases the number of shares an investor owns, but it also typically results in a proportionate decrease in the stock’s per-share price. While less common, property dividends involve distributing assets other than cash or stock, such as shares of a subsidiary company.

Dividend Payment Process

The payment of a common stock dividend involves a series of important dates. The process begins on the declaration date, when the company’s board of directors formally announces the dividend, including the amount, the record date, and the payment date.

Following the declaration date is the ex-dividend date, typically set one or two business days before the record date. This date is crucial for investors: if you purchase the stock on or after the ex-dividend date, you will not be entitled to receive the upcoming dividend payment. Conversely, if you own the stock before this date, you will receive the dividend. The record date is the day on which the company reviews its records to identify all shareholders who are eligible to receive the dividend. Finally, the payment date is when the company actually distributes the dividend to all eligible shareholders.

Taxation of Common Stock Dividends

The taxation of common stock dividends in the United States depends on whether they are classified as “qualified” or “non-qualified” dividends for federal income tax purposes. Qualified dividends receive favorable tax treatment, being taxed at the lower long-term capital gains rates, which are currently 0%, 15%, or 20%, depending on the taxpayer’s overall income bracket. To be considered qualified, dividends must generally be from a U.S. corporation or a qualified foreign corporation, and the stock must be held for a specific period.

The holding period requirement for qualified dividends stipulates that the stock must be held for more than 60 days within the 121-day period that begins 60 days before the ex-dividend date. If this holding period is not met, the dividend is considered non-qualified and taxed at the taxpayer’s regular marginal income tax rate, which can be significantly higher than capital gains rates. Examples of non-qualified dividends include those from Real Estate Investment Trusts (REITs) or Employee Stock Ownership Plans (ESOPs), or dividends received when the holding period requirement is not met. Even if an investor chooses to automatically reinvest dividends to acquire more shares of the company, these reinvested amounts are still considered taxable income in the year they are received. Financial institutions report dividend income to shareholders and the Internal Revenue Service (IRS) on Form 1099-DIV, which details both ordinary and qualified dividends received during the tax year.