Dividends are defined by the IRS as distributions of money, stock, or other property a corporation pays you because you own stock in that corporation. For active trading and investing purposes, we are only concerned with four primary types of dividends:
In the past, the receipt of cash dividend income in the form of a check or reinvested funds was a fully taxable event. As such, dividends were treated as another source of ordinary income and were taxed at your normal tax rate.
However, the Jobs and Growth Tax Relief Reconciliation Act of 2003 changed how some dividends are taxed. Investors pay lower tax rates on dividends received from domestic corporations and qualified foreign corporations. The lower rates also apply to dividends passed on to shareholders from a mutual fund that has received qualifying dividends from stock that it holds. However, the Act did not change the basic character of dividend income:
Dividends are still considered ordinary income and cannot be offset against net capital losses. Therefore dividends are not reported on scheduled d along with stock and option capital gains and losses.
Companies will send you a Form 1099-DIV to let you know that you received a dividend payment, but will not necessarily indicate if your dividends are qualified or not. It is up to you to examine carefully the many factors determining which of your dividends qualify as "capital gains" and should therefore receive the lower tax rate.
One such factor is the holding period. In order to qualify for the new lower taxes on dividends, an investor is required to hold the stock on which the dividends are paid for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the last date on which a shareholder of record is entitled to receive the upcoming dividend.
Dividends must also be received from a domestic corporation or a qualified foreign corporation. A qualified foreign corporation is one that is incorporated in a U.S. possession or is incorporated in a country that has a current tax treaty with the U.S. Check with the shareholders relations staff at the corporation you're investing in to see if they are treated as a qualified foreign corporation.
Shareholders report qualified dividends to the IRS on Line 9(b) of Form 1040
or 1040A.
The tax is calculated by completing either the Schedule D Tax
Worksheet or the Qualified Dividends and Capital Gain Tax Worksheet in the Form
1040 instructions.
All ordinary dividends are reported on IRS Form 1040, Line 9(a).
If
dividends were $1,500.00 or less, shareholders may report them on Form 1040,
Line 9(a) only; if more than an $1,500.00, they should also be recorded on
Schedule B, Part II.
Dividends are not reported on the IRS Schedule D form, therefore TradeLog™ does not import or record cash dividends.
When you receive a stock dividend, you actually receive additional shares of a company's stock based on the number of shares you already own. This is not the same as a regular or cash dividend that you use to reinvest in more shares. With a true stock dividend, you have no option to receive cash.
Stock dividends are the same as stock splits where you end up with more shares than you previously had, but at a lower price. (Or less shares than you previously had at a greater price in the case of a reverse split.)
Stock dividends / stock splits are normally not taxable (subject to some exceptions) because your economic position as a shareholder generally doesn't change as a result. The company issues more shares to each shareholder based on the number of shares they own. The total capitalization of the company and the ownership percentage of each shareholder doesn't change, so the value of your holding is unchanged.
Stock dividends are usually expressed as percentages. If a company declares a 10% stock dividend, for example, it issues one share for every ten shares owned. In stock split terms this would be a 1 for 10 stock split because you get one extra share for every ten shares owned going into the split.
If you receive a stock dividend due to a stock split, you have to recalculate your cost basis for each share owned, the figure used to determine whether you have made a profit, when you finally sell the stocks. (Essentially, the basis is your cost per share adjusted for such events as the stock dividend).
Most brokers report stock dividends on their trade history reports or monthly statements as stock splits, but there is no consistent format of how these are reported from one broker to the next. So most trade accounting software programs do not adjust for stock splits automatically.
However, TradeLog™ features an Adjust for stock split function which enable investors to make the necessary adjustment in a few easy steps. This function will change the number of shares owned as well as the price of these shares, thereby changing the cost basis of each share while the total amount paid for all of your open shares remains the same.
Dividend reinvestment plans (DRIPs) have become quite common and allow the investor to accumulate a significant amount of shares over time. The idea with drips is that any cash dividends received from owning a stock are automatically reinvested by purchasing new shares in that same stock.
Typically dividend reinvestments result in shares being repurchased in fractions of whole shares as the cash dividend may not be divisible into whole share amounts. This is similar to mutual fund purchases which generally are in fractional share amounts.
Dividends received from DRIPs are treated the same as cash dividends for tax purposes and taxes are due in the year the dividend was received even though the dividend was reinvested.
The shares purchased by the drip are treated the same as any other stock purchase and the cost basis for these shares is the price paid when reinvested. Capital gains or losses are realized when these shares are finally sold and get reported to the IRS on schedule d just like any other stock sale.
Occasionally a company will spin-off shares in another company to all of its shareholders. Basically the entire transaction is a zero sum event, where the total cost basis of all the shares owned after the spin-off equals your total cost basis in the shares owned before the spin-off.
So if your cost basis for 100 shares of stock XYZ is $10 per share going into the spin-off, your total cost basis for these 100 shares is $1,000.
If XYZ spins off 1 share of ABC for every 10 shares that you own of XYZ, then your total cost basis for all of these shares, 100 shares of XYZ plus 10 shares of ABC still equals $1,000.
If the price of the 10 shares of ABC you received from the stock spin-off is $4 per share, then your total cost basis for these 10 shares is $40. This amount must be then subtracted from your total cost basis of your original 100 shares of XYZ. These are now worth only $960. Therefore your price per share for XYZ is now $960 divided by 100 shares or $9.60 per share.
This can get really complex, especially when you own many shares purchased at many different prices and you need to figure out your new cost basis in the shares that you are left with after the spin-off, or if the company spins off shares in several different companies.
Occasionally a company will purchase shares of another company and merge the two companies into one, sort of like a reverse spin-off. So if you owned shares in the company that was bought, those shares no longer exist and you now own shares in the parent company instead. As shown above, your total cost basis for these new shares does not change, only the quantity and price of those shares will change.
The information above is not meant to be the definitive discussion on this subject. Rather we are trying to make this as simple as possible so each trader and investor can understand the mechanics behind such adjustments to their cost basis when such events occur in their accounts.
An excellent three part article entitled Stock Splits was featured on the The Motley Fool web site which discusses stock splits, odd lots, and split-ups (mergers) in greater detail.