Dividends and Other Corporate Distributions
Dividends are one type of distribution paid to a taxpayer by a corporation. Taxpayers may receive the following types of distributions from a corporation:
Ordinary dividendsordinary dividendCorporate payments to stockholders out of earnings and profits; taxable as ordinary income.
Nontaxable distributions (includes dividends paid in stock)
Capital gain distributions
Taxpayers will receive a Form 1099Form 1099Report prepared by payer of taxable income; variants include 1099-INT for interest income; 1099-DIV for dividend income; 1099 MISC for miscellaneous income. from the paying corporation and the form will identify the type and amounts of dividends that were paid. Ordinary dividends are the most common type of corporate distribution. They are paid from the earnings and profits of the corporation. Nontaxable distributions are a return of invested capital and are not paid from the earnings and profits of the corporation. They are considered a return of the taxpayer’s investment in the corporation and are not included in the taxpayer’s income. Instead, the taxpayer’s basis in the stock is reduced by nontaxable distributions until the basis reaches zero. After the stock has reached a zero basis, distributions that represent a return of capital are taxed as capital gains. Capital gain distributions are reported either on page one of Form 1040 or on Schedule D.
An advantage that ordinary “qualifying” dividend income has to the taxpayer is that the income is taxed at a favorable (lower) tax rate than other “ordinary income”[4] items. The requirements for an ordinary dividend to be qualifying are covered in Chapter 8, Publication 17. The 2003 and 2006 Tax Acts enacted special lower tax rates for qualifying dividendsqualifying dividendOrdinary dividend that qualifies for a lower (capital gains) tax rate; not all ordinary dividends are qualifying, but all qualifying dividends are ordinary.. For years experts have argued that corporate dividends are taxed twice, once when the corporation pays tax on profits, and once when the dividend is received by the shareholder. To provide some tax relief for individual taxpayers who receive corporate dividends the tax rates on dividends are as follows in Table 3.3, “Tax Rate on Dividends”:
Table 3.3. Tax Rate on Dividends
| Ordinary Tax Bracket | Qualifying Dividend Tax Rate |
|---|---|
| 10% and 15% | 0% |
| Higher brackets | 15% |
It is important for tax students to note just how the dividends get the special tax treatment. Dividend income is first reported to recipients on a Form 1099-DIV. The forms will designate the type of dividend, including whether or not it is a qualifying dividend.[5] A taxpayer reports the dividend on Form 1040 or 1040A and the dividend is totaled with other income to yield the adjusted gross income and later the taxable income. The amount of tax is then computed using the Qualified Dividends and Capital Gains WorksheetQualified Dividends and Capital Gains WorksheetUnnumbered form used to compute tax whenever a taxpayer has qualified dividends and/or capital gains; found in the Form 1040 instruction booklet., which is a page within the instructions for both the 1040 and 1040A (the Worksheet is not a numbered form). On the Worksheet, qualifying dividends and capital gains (capital gains are discussed in Chapter 8, Property Dispositions of this text) are separated from ordinary income and taxed at lower rates and then combined with the tax on ordinary income to yield the total tax.
A corporation can pay a capital gain dividend. It is a dividend that is paid from gain a corporation has made in selling the stock of other corporations. Capital gain dividends are reported on Schedule D, Form 1040 along with gains from the sale of capital assets, which will be discussed in Chapter 8, Property Dispositions of this text.
Go to Publication 17 and read Chapter 8: Dividends and Other Corporate Distributions.
Questions
Amounts paid by which of the following institutions are dividend income?
Cooperative banks
Credit unions
Building and loan associations
Mutual savings banks
None of the above
When is it required to report interest and dividend income on Schedule B (Form 1040)?
Any amount is required to be reported on Schedule B
Only when the total for either is over $100
Only when the total for either is over $1,000
Only when the total for either is over $1,500
None of the above
[4] “Ordinary” tax rates refer to the rate of tax paid on items such as wages, salary, bonus, self-employment income, and other items. There is no reduction in the rates for “ordinary income” components.
[5] In completing questions and problems throughout the text, assume dividends are qualifying unless otherwise stated.
