If you’re interested in investing or enjoy keeping up with business news, you’ve probably heard about companies, trusts, and similar organisations issuing dividend payments to shareholders. Dividends are one way to earn from investments – and an important way some organisations attract and reward shareholders.

This guide walks through the key information you need to know about dividends, including what they are, when and why they’re paid, and their tax implications. Let’s get started.

What are dividends?

Dividends are payments made to shareholders by publicly floated companies, as well as some trusts and investment funds. Dividend payments normally come from the profit the organisation has made, and must be agreed by the board of directors, before facing a vote by shareholders with voting rights. Typically companies will pay dividends at a predetermined time – monthly, quarterly or annually for example – and the board will decide how much of their profits should be retained and reinvested, and how much can be distributed to shareholders.

Dividends are usually paid in the form of a fixed amount of cash per unit of stock owned. However, dividends can also be issued as additional stock or other assets. There is no guarantee that dividends will be paid, nor is there a set amount of company profit which is returned to shareholders. Instead, companies will adjust according to the situation and how the business is doing.

Startups and companies which are looking to grow rapidly may not pay any dividends, as they need to reinvest all the profits they make. More established companies with a steady income, on the other hand, may have a strong track record of paying dividends, which they want to maintain to assure shareholders of their financial fitness. 

Ordinary dividends vs qualified dividends

When dividends are paid, the issuing organisation will specify if they are ordinary dividends or qualified dividends. The main difference to the person receiving these payments is in the way they’re taxed.

In the US, ordinary dividends are taxed like regular income, while qualified dividends are taxed under capital gains rules. Depending on your overall income and tax bracket, you may find the qualified dividends attract a lower rate of tax.

How do dividends work?

Companies and organisations can decide to issue dividends by approval of the board of directors. Dividends are usually presented as a payment per share. So, for example, a company may announce a dividend of USD0.20 per share. If you own 1,000 shares, you’ll receive USD0.20 x 1,000 as a payout – that’s USD200. This may be made as a single payment, or split over the year with a payment per quarter for example.

When a dividend payment is announced, the company will usually also give a payment date, an ex-dividend date, and a record date. In order to qualify for the dividend payment, you must own shares purchased before the ex-dividend date. The record date is then the day on which the final lists of eligible shareholders are drawn up by the issuing organisation.

Company share prices usually react to the announcement of a dividend payment. You may see prices rise on the announcement of a dividend, and then fall again just before the payment is disbursed. Dividend payments may cause other changes in investor sentiment, depending on what analysts make of the amount being paid, and the reasons for the decision by the board of directors.

How to calculate dividend yield?

You may also hear investors and analysts talk about the yield per share of a particular company. This is useful when you’re looking to buy shares for a dividend income and willing to wait several years to see a steady growth of the overall price of the shares themselves. High dividend yield stocks may represent undervalued companies – a target for some investors. This approach also allows for comparison of different investment options side by side, by presenting a percentage yield.

You can get the dividend yield for your chosen company using a Google search, or with the following calculation:

Dividend yield = annual dividend per share/price per share

How often are dividends paid?

Different organisations pay dividends according to their own schedule. A board of directors will announce the intention to pay a dividend, which may be a scheduled dividend or a special dividend. Scheduled dividends typically follow a pattern, while special dividends may be used to reward shareholders following a period of successful trading for the company, or once the company meets a certain milestone. 

When are dividends paid? 

Dividends are often announced and paid annually or quarterly – monthly payments are also possible. Individual companies and organisations make the decision about if – and when – to pay dividends according to the specific situation.

Taxes on dividends

If you receive dividend payments you may need to report them to the IRS and pay taxes on the income. However, the exact way you’ll need to report dividend payments, and what taxes you’re liable for will depend on the specific situation and the amount you receive in dividends. 

Make sure you understand the tax implications when you receive dividend payments. Getting it wrong may result in penalties or having payments withheld. You can find lots of helpful information online on the IRS website, or by talking to a tax professional.

How to declare dividends?

The correct way to declare dividends may vary depending on the organisation which is paying, the amount and the type of payment. 

If you’re paid dividends, the organisation paying out will notify you the amount and type of dividends using Form 1099 – DIV. This should specify whether dividends are ordinary or qualified – which is important when reporting them for tax purposes.

You can then include the information from this document when you complete regular income tax filing with Form 1040, 1040-SR or 1040-NR. You should declare any dividend income, even if you don’t think you’ll need to pay any tax on the amount.

If you have received USD1,500 or more in dividend payments you’ll also need to complete an additional form – Schedule B (interest and ordinary dividends) – to go along with your regular tax filing. Get professional help with your taxes if you’re unsure of the process to follow.

Could you reinvest dividends? 

When a dividend is paid you can either take it as cash or choose to reinvest the amount paid out. If you reinvest your dividends, the money is used to buy more shares. These shares over time will earn more dividends – which means you can compound the amount you’ve invested. If you don’t immediately need the cash flow from dividends, reinvesting can therefore be a smart move.

You’ll probably be able to set up dividend reinvestment with your broker or the company that issued the shares. This will mean the dividends are automatically reinvested and you don’t need to take further action.

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Whether you’re running a company yourself, or thinking of investing in shares to meet your long-term financial goals, it’s helpful to understand dividends. As a way of growing wealth, investing in dividend paying stocks can be a good move. And if you’re a business owner looking towards the future as a publicly floated company, dividends can be a smart way to attract and thank investors who can help your organisation flourish.

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