Dividend Payment - Cash and Stock Dividends

There are 2 common types of dividends. Cash dividends are dividends that are paid in cash, and are the most common type of dividend. Stock dividends are paid in extra shares of stock instead of cash. Sometimes, however, a company will distribute a different type of dividend, such as the stock of a spin-off company.

Whether the dividend is paid as cash or as stock, the payment of a dividend reduces the price per share of the company. If the dividend is paid as cash, then the company will have less cash, reducing its value, and, therefore, its value per share. If the dividend is paid as stock, then there are more shares outstanding, but the value of the company has not increased; therefore, the company’s value per share is reduced. For example, if a company pays a 10% stock dividend, then it will distribute 1 share of stock for every 10 shares that the holders of record own, and the total number of outstanding shares will also increase by 10%. However, the main advantage of a stock dividend for the company is that the retained earnings can all be reinvested for greater growth. The main advantage of a stock dividend for the stockholder is that no taxes have to be paid on the stock dividend until the shares are sold.

Taxation of Dividends

Dividends are subject to double taxation. The corporation must pay taxes on the income used to pay dividends and the shareholders must pay taxes on cash dividends. There is no tax due on stock dividends until they are sold.

Dividends were originally taxed as ordinary income, but the Jobs and Growth Tax Relief Reconciliation Act of 2003 lowered the tax to 5% for stockholders in the lowest 2 tax brackets and 15% for the higher tax brackets. However, it will probably be raised soon by the new Democratic administration.

Many large corporations provide dividend reinvestment plans (DRIPs) for their stock. These programs allow investors to buy company shares directly from the company, void of all brokerage commissions or the need to buy round lots, and the company will reinvest the dividend into additional company stock. In fact, dividends can be used to buy fractional shares of stock. Most companies also allow partial participation where the stockholder can specify the amount to be reinvested and the amount to be paid as cash. While DRIPs are excellent investment vehicles, they differ from stock dividends in that taxes are due on the reinvested dividends in the year that the dividends are earned.