Shareholders, Dividends, and Taxes Overview
If your corporation has issued public shares of stock, you may offer cash distributions to shareholders from time to time. These are typically referred to as "dividends," which are taxed as income, although not all cash distributions technically are dividends. If your company is publicly traded, chances are you have a legal team helping you manage your company's stock and relationships with shareholders. But the following information is intended to give you a general overview of shareholders, dividends, and taxation.
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Dividends at a Glance
A dividend is a distribution of cash or property by a corporation to a shareholder paid out of the corporation's current or accumulated earnings and profits. Although Congress has not provided a comprehensive definition of earnings and profits, it is essentially an economic measure of a corporation's ability to pay dividends without distributing any of the capital contributed by either its shareholders or creditors. Earnings and profits include all items of income, gains, losses, and deductions resulting from the economic activities of the corporation since the later of the date of the corporation's inception or February 28, 1913 (the date the federal income tax was enacted).
Is it a Dividend? Taxation of Shareholder Distributions
In order to determine if a distribution is a dividend, distributions to shareholders are first deducted from current earnings and profits and then from accumulated earnings and profits. If the amount of the distribution exceeds both current and accumulated earnings and profits, the distribution will not be taxed as a dividend but as a sale or exchange of property.
Dividends are taxable to a shareholder as ordinary income. Corporations issue shareholders an annual Form 1099 Dividend, which reports dividends paid during the year. The amount paid is reported by the shareholder as income on Schedule B of the shareholder's return. The shareholder is required to report the dividend amount as income even if the dividend is reinvested in corporate stock. If the dividend is reinvested, the amount reported as income is added to the shareholder's cost or basis in the stock.
If an individual receives a distribution from a corporation that does not qualify as a dividend, the amount received will be reported as a sale or exchange of an asset on Schedule D of the shareholder's return. The gain reported will be equal to the distribution received less the shareholder's cost or basis in the stock. The gain will be either long term or short term depending on whether the shareholder held the stock for a year or more.
Taxpayers often receive dividends from mutual funds. These dividends are categorized as ordinary dividends or capital gain dividends. The characterization of the dividends reflects the investment activity of the mutual fund. Ordinary dividends are reported on Schedule B as ordinary income. Capital gain dividends are reported on Schedule D as long-term capital gain income.
Certain credit unions report interest income as dividend income. Dividend income from credit unions should be reported as interest income on Schedule B.
Contact an Attorney to Learn More About Shareholders, Dividends, and Taxes
Even an honest mistake with regard to dividends or cash distributions to shareholders can have serious consequences. Luckily, you can contact an experienced tax law attorney who can help sort out your taxes and ensure that you're in compliance with the law.