When you own a company's stock, you literally own the company -- a small percentage of the company, yes, but still a very real percentage. As such, when the board of directors decides to distribute a portion of company profits to the owners, you get a cut of the loot. That cut is your dividend, and it can be paid out in either cash or stock.
Approving the Dividend
Some companies pay a dividend like clockwork every quarter. Some never pay dividends, while others pay them only when they don't have anything better to do with the money. Whether a company pays a dividend -- and, if it does, how much it pays -- is up to the board of directors. Most dividends are paid in cash on a per-share basis. For example, if a company that had 150 million shares of stock outstanding decided to pay a $30 million dividend, stockholders would receive 20 cents for each share they owned. Companies that want to hold onto their cash but still pay a dividend can offer a stock dividend, passing out additional stock instead of cash. In a 2 percent stock dividend, for example, stockholders would get one new share for every 50 they owned, provided they were shareholders of record on a specified date.
Declaring the Dividend
After the board approves a dividend, the next step is declaring it -- telling the world that a dividend is coming. The board announces how much the dividend will be and the date on which the company will pay the dividend. Just as important as the payable date is the ex-dividend date, the date by which you must have bought shares in the company to be eligible to collect a dividend. Companies keep track of who owns their shares, and only shareholders of record get dividends. With an ex-dividend date a few weeks ahead of the payable date, the company can be sure it knows who should receive the dividend. If you buy stock after its ex-dividend date, the dividend will go to whomever sold you the shares.
Paying the Dividend
For cash dividends, the company may write checks or send the money by direct deposit when the payable date arrives. For shares purchased directly from a company through a dividend-reinvestment program, the company simply applies the dividend toward the purchase of more shares. With stock dividends, the company credits the shareholder with new shares according to the percentage determined by the board.
Companies report dividend payments to the Internal Revenue Service. For each shareholder who receives at least $10 in dividends in a year, the company must file Form 1099-DIV with the IRS and also send a copy to the shareholder. That's just the minimum reporting requirement; a company can file a form even if it pays less, and shareholders still have to report all of their dividends regardless of whether they get a form. Most dividends are taxed as ordinary income -- the same as the wages from a job. Certain dividends are treated like long-term capital gains, which means the tax rate on them is lower. Form 1099-DIV identifies how dividends are classified.
- Financial Accounting for MBAs, Fourth Edition; Peter Easton
- Securities and Exchange Commission: Ex-Dividend Dates
- National Bureau of Economic Research: Why Do Companies Pay Dividends?
- Internal Revenue Service: Dividends
- Forbes.com: Dividends, Capital Gains and Preferred Stock