Dividends and long-term capital gains are both types of income that individuals can accrue through investments. Dividends refer to financial distributions that a corporation pays you for being one of their shareholders, while long-term capital gains represent the net financial gain that you achieved by purchasing, holding and selling at a profit some type of capital asset. Both dividends and long-term capital gains are subject to the federal income tax, albeit under special rules.
Dividends and long-term capital gains frequently are associated with investing in the stock market. Many public corporations that sell shares of their stock also provide dividends that are paid on a quarterly schedule to their shareholders. They serve as an incentive for shareholders to own stock in the corporations and a source of supplementary income. Long-term capital gains also relate to the stock market because stocks are one of the assets that qualify as "capital," and you can be taxed on any profits you make when you sell a capital asset. If you purchase shares of stock, hold it for a period longer than one year and then sell the shares, the difference between your purchase price of the stock and your sale price of the stock amounts to either long-term capital gains or losses. Long-term capital gains would be if you sold the shares at a profit.
Non-Stock Market Relevance
Neither dividends nor long-term capital gains are limited to the stock market context. Dividends can be paid in a number of settings by corporations or other groups to individuals who are shareholders. For instance, you may receive dividends from a partnership, an estate or a trust. Long-term capital gains can relate to a long list of possible capital assets that you purchase, hold and then sell at a gain, such as a home, a vehicle, bonds, collectibles or home furnishings.
Dividends and long-term capital gains are treated differently for tax purposes. Ordinary dividends that do not qualify as "qualified" dividends -- more on those in a bit -- are treated as ordinary income and are taxed at a rate varying from 10 percent to 35 percent. Corporations that pay you dividends will send you a 1099 Form with the detail of the dividend payments that you received in a tax year. Dividends received through a partnership, estate, trust or subchapter S corporation will require a Schedule K-1, according to the IRS. Meanwhile, long-term capital gains are taxed at a lower rate than ordinary dividends. Typically, long-term capital gains are taxed at no more than 15 percent. However, certain capital items are taxed at higher rates than the capital gains rate. For instance, capital gains on collectibles are taxed at 28 percent.
Qualified Dividends and Overlap with Long-Term Capital Gains
Many dividends are classified as qualified dividends rather than ordinary dividends by the IRS. These dividends must come from American corporations or foreign corporations that meet certain IRS stipulations, and the shareholder must have held the stock attached to the dividend for minimum periods of time, which vary depending on the type of stock. Qualified dividends are treated as capital gains instead of ordinary dividends for tax purposes and are, at the time of this publication, taxed at the same maximum 15-percent rate that long-term capital gains are. However, this situation might be temporary. Until 2001 -- the beginning of the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003, better known as the Bush tax cuts -- all dividends were taxed as ordinary income. The Bush cuts introduced the concept of "qualified" dividends that would share the lower taxation of long-term capital gains. But the Bush legislation is due to expire on Jan. 1, 2013, which means that the favored taxation on dividends could expire with them, unless Congress decides to give the tax bills new life.