What Happens to Dividends in a Stock Portfolio?

Reinvesting rather than spending your dividends can give a growth boost to your portfolio.
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Once upon a time, when your granny was in elementary school, dividend payments were the main reason people owned stocks. Well, everything old is new again: Grabbing dividend-paying stocks has become a trendy investing style. Once you get a dividend, you have a choice: spend it or grow it. If you're young and thrifty, you may be seeking an alternative to spending it.

Check in the Mail

Companies most often pay cash dividends. If you want direct payments, the company will mail you a paper check or make an automated clearing house -- ACH -- electronic transfer into your bank account. Quarterly payments are typical, but some companies pay monthly, while others pay semiannually or annually.

Sweep Account

If you hold your stocks in a brokerage, you likely can establish a sweep account to collect dividends. Most sweep accounts are money market funds that add monthly interest payments. Once a dividend reaches your sweep account, you withdraw the money or use it to buy additional stocks or other investments handled by your brokerage.

Company Reinvestment Plans

Hundreds of domestic companies, as well as foreign companies whose shares you can buy on U.S. stock exchanges, offer dividend reinvestment programs, DRIPs. When you enroll in a DRIP, you no longer receive cash dividends. Instead, dividends buy more stock, including fractional shares, of the company. Whether the company runs a DRIP or uses an agent, the shares from reinvested dividends typically are held in an account administered by the program, even if you keep the certificate for the primary shares. You may be able to buy the shares from reinvesting dividends at a discount to market price. If the company runs its own DRIP, it often doesn't charge commissions on DRIP purchases. If a transfer agent runs the program, you may pay a slight fee for each reinvestment transaction.

Brokerage Reinvestment

You also may be able to reinvest dividends for certain U.S. companies, listed foreign companies, exchange-traded funds and closed-end funds through your brokerage. In most cases, you first must register for reinvestment privileges. Then, you can choose for each stock purchase whether you want dividends reinvested. If you do investment transactions online, you generally can change dividend reinvestment choices whenever you want. In most cases, brokerages charge no fee to reinvest dividends. Some brokers -- Sharebuilder.com, for example -- specialize in dividend reinvesting.

Taxes on Dividends

Whether you receive a cash payment or reinvest the dividend, it will be included on a Form 1099-DIV and must be reported as income in the year dividends are paid. Reinvested dividends then become part of the tax basis for the stock and will decrease your capital gains tax liability when you sell. The 1099-DIV differentiates between "qualified" and "nonqualified" dividends. Qualified dividends are taxed at 15 percent; nonqualified dividends are taxed at your ordinary income rate.

Stock Shares as Dividends

Sometimes a company pays dividends by granting you additional shares, either of its stock or perhaps a subsidiary or spin-off company. Stock dividends typically are issued in proportion to each share you own -- 0.01 additional share for each share owned, for example. If a company pays a stock dividend, it will notify you and include the dividend on your 1099-DIV if you need to account for the transaction on your next tax return. However, dividends paid in stock often carry no immediate tax liability. Instead, the tax basis in your company stake decreases; more shares with no increase in your total investment yields a lower per-share tax basis and a larger capital gains liability when you sell the stock.

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