A dividend is an amount of money that a company distributes to its shareholders on a periodic basis. Dividends are often paid out quarterly, although they may also be paid annually. A dividend can take the form of a cash payment, shares of stock or other property.
Typically, dividends are calculated in a dollar amount representing a portion of the company’s earnings. This amount can be based on a predetermined dividend-per-share amount or as a percentage of the current market price.
Ways of Paying Dividends (or Not)
Not every company offers dividends to its shareholders. With newer companies, for example, it may be more appropriate for any earnings to be reinvested in the company to advance growth. Larger, more established companies, on the other hand, may be more inclined to offer dividends to shareholders. Companies that have consistently increased their dividend payout for 25 years or longer consecutively are referred to as “dividend aristocrats.”
Companies that issue dividends can do so using one of several models. For instance, companies that adopt a stable dividend policy offer a steady dividend payout to their investors, regardless of earnings. This policy can be adapted to focus on targeting a specific dividend-to-earnings ratio. A constant payout ratio uses a specific percentage to determine dividends, meaning the amount paid as dividends varies according to earnings.
Dividends and Your Taxes
Dividends are taxable income. Ordinary dividends, which are derived from stocks or mutual funds, are taxed at ordinary-income rates. Qualified dividends are a type of dividend that’s subject to the federal capital gains tax. To be recognized as qualified, the dividend must have been paid by an American company or qualifying foreign company. Most regular dividends you receive are qualified; they meet the holding requirements below.
Qualified dividends can’t be listed with the IRS as ordinary, and the investor must have held them for a required holding period. Common stock shares must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend rate. With preferred stock, the holding period is more than 90 days before the ex-dividend date, “if the dividends are due to periods totaling more than 366 days.”
Dividends from some investments do not qualify for capital gains treatment. These include those from real estate investment trusts and master limited partnerships.