What is a Dividend?

A dividend is a payment or distribution made by a company to eligible shareholders as a share of its profits, approved by the board of directors. The frequency of dividend payments varies across companies and industries, with most paying quarterly.

Dividend stocks often attract investors due to their reliable quarterly income, stability, and historical buffering during market downturns.

Cash dividends are commonly paid based on the number of shares owned and sent as checks or credit to a brokerage account, while stock dividends are paid in fractional shares.

U.S. corporations typically pay dividends taxed as long-term
capital gains, known as qualified dividends. The IRS can tax these dividends as low as 0% and no higher than 20% depending on an individual’s tax bracket. The minimum holding period is a key factor in determining the tax rate. Employee stock options, which are typically identified as compensation, can also disqualify dividends from lower tax rates. The type of company paying a dividend is also a factor. REITs, foreign companies, and MLPs usually don’t qualify for lower tax rates due to their pass-through structure, which doesn’t pay federal income tax.

Why are Dividends Important to Investors?

Dividends can be utilized in various ways, depending on your personal financial situation and investment objectives.

Dividend-paying stocks offer recurring cash flow, beneficial for retirees and businesses, as they allow investors to choose to keep the money received.

A company dividend reinvestment plan (DRIP) is a viable option for investors seeking to let their investments grow, as it allows them to use their dividends to purchase additional shares at a consistent rate.

Dividend stocks are essential for a balanced portfolio, providing short-term income and long-term growth opportunities for shareholders and investors, making them beneficial for overall portfolio growth.

Types of Dividends

Dividends are a strategy companies use to attract investors, offering various forms and timings.

Cash Dividends (most common): Cash dividends are paid out by transferring a cash amount to the shareholders.

Stock Dividends: Companies may offer dividends in the form of extra shares, which are tax-free until the shareholder sells them, but this can dilute the share price, as each shareholder owns the same percentage of the company post-dividend.

Scrip Dividends: A company may issue scrip dividends, a promissory note, if it lacks funds to issue dividends in the near future, potentially including interest.

Property Dividends: Some companies offer dividends by distributing assets or inventories to shareholders, based on the fair-market value of the asset, although this is less common.

Liquidating Dividends: Paid during partial or full liquidation, where the company returns the original contribution amount, making them usually not taxable.

Dividend Dates

Declaration date: A company announces it will be paying a dividend.

Ex-dividend date: Last day a shareholder can purchase a share of the company’s stock to be eligible to receive the next dividend payment.

Settlement Date: The day a trade is finalized, a shareholder officially owns the stock or receives payment, typically two days after a buy order is made.

Record date: Last day a shareholder must own a share of a company’s stock to be eligible to receive the next dividend payment (usually means trades made on this date aren’t eligible for dividends).

Payment date: Day each eligible shareholder will be credited with the dividend payment.

Dividend Measurements

Dividend Rate: The dividend rate is the percentage of a stock’s share price shareholders receive in dividends.

Example: A stock trading at $100 a share and pays a dividend of $5 each quarter (or $20 a year), the dividend rate is 20%.

Dividend Payout Ratio: A company’s dividend payout rate is the percentage of its earnings that are paid out in dividends.

Example: A business has earnings of $100,000 and pays total dividends of $20,000, the dividend payout ratio would be 20%.

Dividend Yield: The stock’s annual dividend divided by its current share price.

Example: A stock trading at $100 with an annual dividend per share of $5 would result in a dividend yield of 5%.

Non-qualified Dividends

Non-qualified dividends, also known as ordinary dividends, do not meet IRS requirements for a lower tax rate. They include dividends from certain foreign companies, distributions from certain U.S. entities, such as such as real estate investment trusts (REITs) and master limited partnerships (MLPs), employee stock options, and special one-time dividends.

Furthermore, non-qualified dividends may result if the company is not part of a comprehensive income tax treaty with the U.S. or if its stock isn’t easily tradable on an established U.S. securities market.

Qualified Dividends

Qualified dividends are dividends from domestic and certain foreign corporations held for a minimum holding period and are taxed similarly to long-term capital gains, which results in lower tax rates compared to ordinary income.

These qualified dividends are taxable federally at the capital gains rate, based on the investor’s modified adjusted gross income (AGI) and taxable income at 0%, 15%, and 20% rates.

The holding period requirement for qualified dividends received in shares held directly or in mutual funds during the tax year remains the same, but the method of determining it may vary.

Qualified Dividends Requirements for Mutual Funds

• The mutual fund must have held the security for at least 61 days out of the 121-day period starting 60 days before the security’s ex-dividend date
• Certain preferred stock securities must be held for 91 days before the ex-dividend date, and the fund must distribute the dividend-generating amount to the investor
• To qualify for the ex-dividend date, you must have held the fund’s applicable share for at least 61 days out of the 121-day period starting 60 days before the fund’s ex-dividend date

Qualified Dividends Requirements for Stocks

• The investor must have held shares of the stock for at least 61 days out of the 121-day period that began 60 days before the ex-dividend date
• For certain preferred stock, the security must be held for 91 days out of the 181-day period beginning 90 days before the ex-dividend date.

Check out additional Investment Insights.