Skip to main content

Dividend Income: How is dividend income taxed?

dividends, dividend income, taxing dividends, how to tax dividends, are my dividends taxed, how are dividends taxed, dividend taxationStock ownership results in dividend income. U.S. tax code defines a dividend as a distribution of property (cash or property) by a corporation to a stock owner. The tax code specifies that the distribution comes from the company's earnings and profits (E&P). The specification is important because the source of the distribution determines the taxability of the dividend income [side note: taxability should definitely be a word].

The company should alert you of the source of the dividend income. Additionally, the company will take care of the dividend distribution accounting. So, it is not necessary for you to understand dividend tax accounting. However, in my opinion, it is always helpful to have a basic understanding of tax-related topics. So, I will briefly discuss the tax accounting rules relating to dividend distributions.

Related Posts
The Guide to Taxable Income versus Nontaxable Income
How to determine your tax filing status?
How to Pay Taxes as an Independent Contractor?

Dividend Income

Dividend Income Taxability: What is the source of the dividend income?

As I stated, the source of the dividend determines the taxability of the dividend income. Specifically, the availability of E&P and your stock basis determine how the dividend income is taxed. If the dividend distribution comes out of E&P, then normal rules apply, and the dividend income is taxed like a normal taxable dividend. If the distribution does not come out of E&P (no E&P available), then the dividend income is not taxable, but instead, the dividend distribution decreases your stock basis in the company. Lastly, if the dividend distribution does not come from E&P, and you lack sufficient stock basis in the company, then the dividend distribution is taxed like capital gain income. Please see the summary of the rules below:
  • E&P: Yes → taxable dividend
  • E&P: No → Stock basis: Yes → nontaxable dividend and stock basis reduced (ROC)
  • E&P: No → Stock basis: No → taxable capital gain

Taxable Dividends: What amount to include in gross income?

A company may distribute dividends in a variety of forms. For example, a company may distribute a cash dividend, a property dividend, or a stock dividend. When it relates to taxable dividends, cash dividends and property dividends apply. If you receive a cash dividend, you should include the amount received in gross income. If you receive a property dividend, you should include the fair market value of the property in gross income.

Taxable Dividends: What is the tax rate for dividends?

Qualified dividends receive a special tax rate. Therefore, you will pay a lower tax rate on your qualified dividends. Make sure to research if your dividends qualify as qualified dividends. If so,
the qualified dividend tax rate ranges from 0% to 20%. Specifically, lower-income taxpayers pay a 0% tax rate on dividend income. Higher-income taxpayers pay a 20% tax rate on dividend income. Those taxpayers (most) in-between pay a 15% tax rate on dividend income. The special rate tax brackets can be found on the IRS website.

What about tax-free distributions?

A company distribution to a stockholder may be tax-exempt. If so, you will not include the distribution amount in gross income. The following items should be tax-exempt distributions.
  • Return of Capital (ROC): if the company does not have E&P, and you have sufficient stock basis, you treat the distribution like a return of capital. A return of capital is not included in gross income.
  • Stock dividend: A stock dividend does not result in a taxable event. The stock dividend will cause an adjustment in your stock basis in the company based on the class of stock distributed. An exception to this rule exists if the stock dividend has cash/property options attached. If so, the stock dividend is taxable at the FMV of the dividend. 

In conclusion

The tax law surrounding dividend income is somewhat complex. The company will be in charge of accounting for the source of the dividend distribution. Remember that the accounting rules differ based on the source of the dividend. Additionally, taxable dividends should be included in gross income. However, the taxable dividend amounts will be taxed at special, lower tax rates.

I hope you furthered your understanding about dividend income and the related dividend distribution tax accounting concepts. Please share with others who may also benefit from learning more about how dividends are taxed.

Please comment below if you have any questions or comments relating to dividend income!


Popular posts from this blog

Gambling Winnings & Losses: How to report gambling income and losses

People love to gamble.  During the past NFL Super Bowl (2019),  gamblers wagered approximately $146 million in Nevada’s sports books, which fell short of the record set the year before of $159 million. The gambling industry continues to grow as U.S. legislation becomes less restrictive relating to the gambling industry.  Because of the size of the gambling market, the IRS set forth guidance to control the tax treatment of gambling winnings and losses. I will discuss income and losses, record keeping, reporting forms, and special rules. If you participate in gambling activities, it is important to know the unique personal tax rules. The term 'gambling' applies to a wide range of activities, including: sports betting, casino games, lotteries, etc. You will need to follow the established gambling tax rules when reporting winnings and losses from gambling activities. Related Posts IRA Income: Must know tax rules relating to your IRA Are your income items taxable? Gamblin

Cryptocurrency Taxation: How does the U.S. tax cryptocurrency? - Textbook Tax

The cryptocurrency market continues to rise in popularity in the U.S. and throughout the world. The decentralized finance ("Defi") sector has seen massive growth. Additionally, ease of access has increased as new and established companies offer crypto services and exchanges. As more and more individuals and institutions adopt cryptocurrency, it becomes more important for people to understand the tax laws and regulations governing the cryptocurrency industry. It is important to note that each country views and regulates virtual currency differently.  The scope of this article covers the crypto tax laws in the United States.  T he IRS defines virtual currencies as  digital representations of value that function as mediums of exchange, units of account, and/or stores of value. Further, t he U.S. views crypto as property subject to capital gains and losses for US federal tax purposes. Based on its designation as property, i n general, there are four taxable events when dealing an

Tax Tips for Remote Workers: Can you claim the home office deduction on your tax return if you worked from home?

You may claim the home office deduction on your tax return if you used part of your home for business. U.S. tax law allows you to deduct expenses related to the business use of your home on your tax return. The tax deduction applies to both homeowners and renters as well as all types of homes. You determine the amount of expense related to business use based on a standard rate provided by the IRS or a calculated rate established by the percentage of your home utilized specifically for business. The two requirements to claim the home office tax deduction include: (1) regular and exclusive use and (2) principal place of your business. Because the COVID-19 pandemic required millions of people to work from home during 2020, many people are wondering if they can claim the home office tax deduction on their 2020 tax return. Below, I will explain in detail the home office deduction requirements to help you determine if you can deduct home office expenses on your tax return. Fair warning,