Taxation of Dividends

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Introduction

There is sufficient proof to suggest that investing in stocks is one of the most effective and easy ways to create wealth in the long term. The term stock refers to a legally acceptable way of becoming part of the ownership of a publicly listed company. In many cases, the term securities may be used interchangeably to mean stocks. For corporations that want to increase their capital and liquidity, selling stocks is one of the ways through which they do this. When companies sell stock to investors, they cede some ownership to the new investors, and that would affect many aspects of the management of the company. Dividends are sums of money that companies pay to the shareholders at regular intervals when they make profits. There have been many discussions with regards to whether dividends need to be taxed because the dividends are paid when organizations have already remitted their taxes. However, there are special circumstances in which dividends are subject to tax. The paper examines the circumstances under which the government taxes the dividends that have been paid out to individuals.

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Taxation of dividends

As indicated in the introduction of the paper, dividends are sums of money that shareholders receive from their companies at regular intervals when the companies make profits. Ordinarily, dividends given out to the shareholders are in the form of cash. However, in some instances, individuals and companies may agree to pay out dividends in varied forms such as stocks, debt payments, services or properties (Jacob et al, 2015). Instructively, these dividends are paid out when the company has already paid its tax obligations. As such, the conventional practice is not to tax the monies that are given out to the shareholders. Dividends may be classified into two categories namely ordinary dividends and qualified dividends. Ordinarily, the amount of dividends reflects the earnings of a company. When dividends are paid out from the earnings of a company, they are referred to as ordinary dividends. On the other side, qualified dividends are those that are classified as capital gains, and they are the ones that are usually taxed.

In America, companies that pay dividends are under obligation to disclose the amount of dividend that they have paid out to the shareholders during a particular year. When payments are made over $10, the companies must disclose the exact value of the shares that they have paid out to the shareholders. In return, when individuals are filing their tax returns, they are under obligation to include these shares in their statements. Ownership of companies exists in different forms. The form of ownership would play a critical role in the determination of whether there will be taxes or not. For example, in partnerships, LLCs and S Corporations, the partners or shareholders in these types of organizations do not receive dividends in ways similar to the ordinary shareholders. The partners or shareholders in these kinds of companies file a different dorm that is referred to as schedule K-1 (Daunfeldt et al, 2015). The form provides in details the incomes of the individuals in a manner that reflects on the distributive income from the profits or losses of the company.

Dividend tax is a common form of taxation that applies to shareholders in the country. The United States of America considers dividend tax as a form of a taxable distribution that does not belong to the long-term capital gain bracket. In most cases, individuals through their distributions made through their shareholders pay the dividend taxes.

Dividend Tax Rates by Types

Dividend payments are categorized differently. The Publication of IRS 550 comprehensively spells out the categorization of different dividends, and these categorizations have been used as the foundation of tax rates in the country. It is important to note that some countries do not have provisions for taxation of dividends since they feel it is a form of double taxation. However, the following are some of the categories of dividends and the rates of taxation that apply to them;

Qualifies dividends

Strictly to calculate the tax dividends, ordinary stocks are those that have been held for a period exceeding sixty days during the period preceding the 121-day period that usually begins before the 60-day date of the ex-dividend. Ordinarily, these dividends are taxed at rates of between 5% and 15% depending on the income tax bracket upon which the investor falls. In this arrangement, the investors who fall in the income tax bracket of 25% and above pay 15% of their dividends as taxation. However, those investors that belong to the income tax bracket of below 25% get their dividends taxed at 5% (Daunfeldt et al, 2015). In this case, it is apparent in the dividend taxation also follows the principles of taxation.

Non-qualified dividends

All the dividends that do not meet the criteria set for the qualified dividends belong to the category of non-qualified dividends. In these kinds of dividends, the tax rates usually assume the tax rates that apply to the income tax bracket of the investor. For example, if an individual’s income tax bracket is 35%, then an individual’s dividend tax will be 35% (Daunfeldt et al, 2015). Before the introduction of the new law, individuals belonging to the non-qualified dividend tax category used to pay dividend taxes in amounts equivalent to the rates applicable to the long-term capital gains.

In addition to the federal taxes that are categorized as either qualified or non-qualified, investors also pay certain taxes on their dividends that are referred to as net investment incomes tax. These kinds of taxes do not depend on the qualifications or non-qualifications of the dividends. For individuals who have modified Adjusted Gross Income (AGI) that supersede $200,000 or joint filers whose AGI stand at figures above $250,000, they are subject to a 3.8% of their dividends (Jacob et al, 2015). These adjustments would have net effects on the overall tax that the shareholders would be paying.

The stock is one form of investment. In an economy, there are various sectors in which individuals may choose to invest. However, tax rates are usually different from one industry to another. In the stock market, the fact that there are preferential tax rates applicable on qualified dividends make investing in stock a desirable option among all other investment options. However, the presence of preferential taxes on investment in stock does not take away the incredible risks that are contained in this sector. However, unlike other sectors, it improves the prospect of investors retaining their hard-earned money since only a small portion will go to the government in the firm of taxes. Argument against dividend taxation Many countries do not tax dividends that are paid out to investors. The primary argument for the elimination of taxation on dividends is the tragedy of double taxation. As indicated earlier in this paper, companies usually pay dividends to their shareholders on their net income. That means that dividends are paid after the companies have paid corporate tax. In the long run, taxing individuals when they have made contributions through the corporate tax is an act of punishing productive Americans. Some people say that these taxations discourage investments since they end up taking away the products of hard work among the investor s without justifiable grounds. The second argument against dividend taxation is that it has the effect of distorting the behavior of both the corporations and the investors. One of the ways through which these taxations influence corporations is that it compels them to resort to financing their activities through debt. The argument behind this approach is that while interests on debts are tax-deductible, the dividend payouts are not tax deductible (Lee, 2017). The application of this approach may also affect investors in the sense that debts make an organization to be financially fragile and that may, in the end, gave repercussions on the investors.

Another way in which the taxation on dividends affects companies and investors is that it motivates companies to withhold profits and fail to pay dividends. As indicated, the dividend taxes are paid only when the dividends are remitted. To beat this provision, organizations may choose not to pay out dividends to its investors, and as a result, there will be no tax due. That course of action has the effect of freezing the capital that the investors may want to invest in other productive sectors of the economy.

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Taxation of dividends. (2020, Jan 10). Retrieved December 2, 2022 , from
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