How Are Dividends Taxed?

If you’re interested in how companies reward their shareholders, dividends are a great place to start. Dividends are payments that companies make to people who own their stock (called shareholders). It’s a way for companies to share their profits with investors.

What Are Dividends?

A dividend is a sum of money that a company gives to its shareholders out of its earnings (or profits). Not all companies pay dividends, but many do, especially those that are large and well-established. For example, if you own shares of a company like Apple or Coca-Cola, you might receive a dividend payment every few months, as long as the company decides to distribute profits to shareholders.

Think of it this way: When you buy a share of a company’s stock, you become a small owner of that company. If the company does well and earns money, it may choose to distribute some of that profit to you in the form of dividends.

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How Are Dividends Taxed?

Dividends are great because they give you cash just for holding stock, but it’s important to know that you usually have to pay taxes on them. How much you pay depends on the type of dividend and your income level.

  1. Qualified Dividends – These are dividends from U.S. companies (or certain foreign companies) that meet specific requirements. Qualified dividends are taxed at a lower rate, similar to long-term capital gains (usually 0%, 15%, or 20%, depending on your income level).
  2. Ordinary Dividends – These don’t meet the requirements to be “qualified” and are taxed at the same rate as your regular income. So, if you fall in a 22% income tax bracket, that’s how much you’ll pay on ordinary dividends.

It’s important to check the tax form you get from your broker or company at the end of the year, as it will tell you which type of dividend you received.

Different Types of Dividends

Not all dividends come in cash, and there are different kinds depending on how a company chooses to share its profits. Here are the most common types:

  1. Cash Dividends – This is the most common type. Companies pay shareholders a certain amount of money for each share they own. For example, if you own 100 shares of a company, and the company pays a $2 cash dividend per share, you’ll get $200.
  2. Stock Dividends – Instead of giving cash, some companies reward shareholders with more shares of stock. This can increase the number of shares you own without you having to buy more, but you may owe taxes on the value of the shares received.
  3. Property Dividends – Rarely, companies might give shareholders physical assets, such as products or property, instead of cash or stock. This type of dividend is not common but can happen.
  4. Special Dividends – These are one-time payments that a company makes when it has extra profits it wants to share with its shareholders. Unlike regular dividends, special dividends aren’t paid consistently.
  5. Preferred Dividends – These are dividends paid to holders of preferred stock, which is a special class of stock. Preferred shareholders get paid dividends before regular (common) shareholders, and their dividends are usually fixed, meaning they receive the same amount every time.

Conclusion

Dividends are an excellent way for companies to share their success with shareholders. Whether you receive cash or stock, dividends provide an extra reward for being an investor.

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