A corporation may distribute property to its shareholders. When the distribution is paid from earnings and profits, it is classified as a dividend and is taxable. Corporations must report dividends of $10 or more on Form 1099‑DIV. Partnerships, S corporations, estates, and trusts pass dividends through to owners on Schedule K‑1.
Dividends are classified as ordinary or qualified, each with different tax treatment.
Ordinary Dividends
Ordinary dividends are the most common type of corporate distribution. They are paid from earnings and profits and are taxed as ordinary income.
Unless the payer specifies otherwise, dividends on common or preferred stock are treated as ordinary.
Qualified Dividends
Qualified dividends are included in ordinary dividends but receive preferential long‑term capital gain rates (0%, 15%, or 20%).
To qualify:
- The dividend must be paid by a U.S. corporation or a qualified foreign corporation.
- The taxpayer must meet the holding period requirement:
- Held the stock more than 60 days during the 121‑day period beginning 60 days before the ex‑dividend date.
Holding Period Rule
- Count the day the stock is sold, but not the day it is acquired.
- The ex‑dividend date is the first day a buyer is not entitled to the upcoming dividend.
If the stock is not held for the required number of days, the dividend is not qualified, even if reported as such on Form 1099‑DIV.
Dividend Reinvestment Plans
Some corporations allow shareholders to reinvest dividends to purchase additional shares.
Tax rules:
- The dividend is still taxable even if reinvested.
- If shares are purchased at a discount, the fair market value of the additional stock is taxable as dividend income.
Money Market Funds
Amounts received from money market funds are reported as dividend income, not interest. Money market funds are mutual funds, not bank accounts.
Capital Gain Distributions
Capital gain distributions from mutual funds and REITs are always treated as long‑term capital gains, regardless of how long the taxpayer held the shares.
If the fund retains its long‑term gains and pays tax on them, shareholders receive Form 2439 showing their share of undistributed gains.
Taxpayer actions:
- Report undistributed gains as long‑term capital gain on Schedule D
- Claim a credit or refund for tax paid by the fund by checking the Form 2439 box in the payments section
Non‑Dividend Distributions (Return of Capital)
A non‑dividend distribution is a return of the shareholder’s investment, not a dividend.
Rules:
- Reduces the shareholder’s basis in the stock
- Not taxable until basis is reduced to zero
- Any further distributions are capital gains
- Holding period determines whether the gain is short‑term or long‑term
Stock and Stock Rights Distributions
Distributions of a corporation’s own stock or stock rights are generally not taxable.
However, they are taxable if:
- Shareholders may choose cash or property instead of stock
- Some shareholders receive property while others receive an increased ownership percentage
- The distribution is convertible preferred stock that changes ownership
- Preferred stock is distributed to some shareholders and common stock to others
- The distribution is made on preferred stock
When taxable, the fair market value of the stock or rights is included in income.