How are Dividends Taxed to Shareholders and Business Owners?
Dividends are distributions of the profits of a corporation to its shareholders and owners. Typically, dividends are distributed at specific times during the year, often quarterly.
Joshua Kennon, Investing for Beginners Expert, reminds us that the purpose of a corporation is basically to pay dividends to the shareholders as a reward for investing in the company. While dividends are valuable, like anything else of value that U.S. citizens receive, they are considered "income." And, as income to the shareholders or company owners, dividends are taxable.
Tax on Dividends to Shareholders
Companies paying dividends must provide shareholders receiving those dividends a report showing the amount of the dividends paid to that shareholder for the year. The report is made, on payments over $10 for the year, to recipients on Form 1099-DIV.
If your business has paid dividends to shareholders, you must also provide the IRS with a consolidated report by the end of January, for all dividends paid to all shareholders during the prior year. In addition, the company must submit a transmission Form 1096 to the IRS before the end of February, compiling all payments made to shareholders.
Dividends are reported by shareholders on their personal tax returns, on Schedule D (Capital Gains and Losses) and a total of all dividends received should be included on the income section of Form 1040.
Dividends are taxed at a special dividend tax rate. In most cases, dividends are taxable as ordinary income to the recipient. In some cases, a dividend might be subject to capital gains tax as a qualified dividend. To learn more about qualified dividends, see IRS Publication 550. If an individual has received over $1500 of ordinary dividends during a year, he or she must file Schedule B - Interest and Ordinary Dividends.
Tax on Dividends to Company Owners, Partners, LLC Members, and S Corporation Owners
Partners in partnerships and LLCs and owners of S corporations do not receive dividends in the same way as shareholders in a corporation do. If you are the partner of a partnership or owner of an s corporation, you will receive a Schedule K-1 which details income you received from the business through your distributive share of the company's profits/losses, and capital gains.
Dividends and "Double Taxation"
Double taxation refers to the fact that dividends are taxed twice. First, the dividends distributed by the corporation are profits (part of the business net income) not business expenses and are not deductible. So the corporation pays corporate income tax on profits distributed to shareholders. Then, the shareholders pay income taxes personally on those dividends.
The information in this article is intended to be general, not tax or legal advice. Taxes and laws are always changing, and each business situation is unique. Check with your tax and legal advisors before making any decisions that could affect your business taxes.