You may receive different types of dividends or other distributions from your investments in stocks and mutual funds, with different effects for tax purposes. Some types of dividends are reported as ordinary income and other dividends and distributions may receive special tax treatment, such as a capital gain, and may affect your basis in the stock or mutual fund shares.
Ordinary dividends are usually paid in cash and are reported in box 1a of Form 1099-DIV. These dividends are reported as dividend income on your tax return and are taxed as ordinary income at your effective income tax rate. Ordinary dividends could also be paid in the form of property and would generally be reported at the fair market value of the property.
As indicated by the IRS, you have to report all your taxable dividend income even if you don’t receive a Form 1099-DIV. For example, you may receive your distributive share of dividends from a partnership or S corporation. These would be reported on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S).
If you receive a dividend from a mutual fund or a company and you have a dividend reinvestment plan, you would generally report the dividend as taxable income at the fair market value of the stock on that date. Then you would assign the value of the dividend as your basis in the additional shares in the mutual fund or the additional stock you effectively purchased. A dividend reinvestment is treated as if you had received the dividend in cash and used the cash to purchase additional shares.
If you have a dividend reinvestment plan that allows you to purchase stock at less than the fair market value, you would report dividend income at the fair market value of the stock you buy. If the plan allows you to invest more cash to purchase shares of stock at less than fair market value, you would report the difference between the cash you invest and the fair market value of the stock as dividend income.
Qualified dividends are reported in box 1b of Form 1099-DIV. These dividends qualify for capital gains treatment at either 0% or 15% (in effect for 2010) depending on your total taxable income and tax rate. If the regular tax rate that applies to you is 25% or higher, the qualified dividends would be taxed at 15%. If your regular tax rate is lower than 25% the qualified dividends would be taxed at 0%.
A company may issue a dividend in the form of the company’s own stock instead of cash. A stock dividend would generally not be reported as taxable income. But you would need to reallocate your basis in the old stock to the old and new stock.
According to the IRS, a stock dividend would be taxable if you had the right to receive cash or other property instead of stock, if the distribution gives cash or other property to some shareholders and an increase in the percentage interest in the company to other shareholders, if the distribution is made in convertible preferred stock, the distribution gives preferred stock to some common stockholders and common stock to other common stockholders, or the distribution is on preferred stock.
If you have an investment in a mutual fund or real estate investment trust (REIT), you may have undistributed capital gains. These are long term capital gains that the mutual fund or REIT keeps and pays tax on. They are reported to you on Form 2439. You would report the amount shown in box 1a of this form as a long term capital gain on Schedule D. This amount would also be added to your basis in the mutual fund shares. You can claim a credit for the tax reported in box 2 of Form 2439 on line 71 of Form 1040.
Part of an undistributed capital gain could be unrecaptured section 1250 gain, gain from qualified small business stock, or collectibles gain. If this is the case, the corresponding amounts will be reported in boxes 1b, 1c, or 1d, respectively, on form 2439.
You might also receive distributions that are returns of capital. These are reported as non-dividend distributions in box 3 of Form 1099-DIV that you receive from the mutual fund. These distributions are not taxable and they reduce your basis in the mutual fund shares.
If you have stock in a company that goes through a partial or total liquidation, you may receive a liquidating dividend. At least part of a liquidating distribution is a return of capital. The distribution may be paid in installments and is reported in boxes 8 and 9 of Form 1099-DIV. Once you have recovered your basis in the stock, any additional amount of a liquidating dividend is reported as a capital gain.
Sources:
Bruce Tintelnot, How do I Calculate a Stock Basis with Dividends? Bright Hub
Cost Basis: Tracking Your Tax Basis, TurboTax
Form 1040, U.S. Individual Income Tax Return
Form 1099-DIV, Dividends and Distributions
Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains
Publication 550, Investment Income and Expenses, IRS
Types
Schedule D, Capital Gains and Losses
Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc.
Schedule K-1 (Form 1120S), Shareholder’s Share of Income, Deductions, Credits, etc.