Stocks - Dividends
By: Art Kamlet
A company may periodically declare cash and/or stock dividends. This article deals with cash dividends on common stock. Two paragraphs also discuss dividends on Mutual Fund shares. A separate article elsewhere in this FAQ discusses stock splits and stock dividends.
The Board of Directors of a company decides if it will declare a dividend, how often it will declare it, and the dates associated with the dividend. Quarterly payment of dividends is very common, annually or semiannually is less common, and many companies don't pay dividends at all. Other companies from time to time will declare an extra or special dividend. Mutual funds sometimes declare a year-end dividend and maybe one or more other dividends.
If the Board declares a dividend, it will announce that the dividend (of a set amount) will be paid to shareholders of record as of the Advertisement
RECORD DATE and will be paid or distributed on the DISTRIBUTION DATE (sometimes called the Payable Date).
Before we begin the discussion of dates and date cutoffs, it's important to note that three-day settlements (T+3) became effective 7 June 1995. In other words, the SEC's T+3 rule states that all stock trades must be settled within 3 business days.
In order to be a shareholder of record on the RECORD DATE you must own the shares on that date (when the books close for that day). Since virtually all stock trades by brokers on exchanges are settled in 3 (business) days, you must buy the shares at least 3 days before the RECORD DATE in order to be the shareholder of record on the RECORD DATE. So the (RECORD DATE - 3 days) is the day that the shareholder of record needs to own the stock to collect the dividend. He can sell it the very next day and still get the dividend.
If you bought it at least 3 business days before the RECORD date and still owned it at the end of the RECORD DATE, you get the dividend. (Even if you ask your broker to sell it the day after the (RECORD DATE - 3 days), it will not have settled until after the RECORD DATE so you will own it on the RECORD DATE.)
So someone who buys the stock on the (RECORD DATE - 2 days) does not get the dividend. A stock paying a 50c quarterly dividend might well be expected to trade for 50c less on that date, all things being equal. In other words, it trades for its previous price, EXcept for the DIVidend. So the (RECORD DATE - 2 days) is often called the EX-DIV date. In the financial listings, that is indicated by an x.
How can you try to predict what the dividend will be before it is declared?
Many companies declare regular dividends every quarter, so if you look at the last dividend paid, you can guess the next dividend will be the same. Exception: when the Board of IBM, for example, announces it can no longer guarantee to maintain the dividend, you might well expect the dividend to drop, drastically, next quarter. The financial listings in the newspapers show the expected annual dividend, and other listings show the dividends declared by Boards of directors the previous day, along with their dates.
Other companies declare less regular dividends, so try to look at how well the company seems to be doing. Companies whose shares trade as ADRs (American Depositary Receipts -- see article elsewhere in this FAQ) are very dependent on currency market fluctuations, so will pay differing amounts from time to time.
Some companies may be temporarily prohibited from paying dividends on their common stock, usually because they have missed payments on their bonds and/or preferred stock.
On the DISTRIBUTION DATE shareholders of record on the RECORD date will get the dividend. If you own the shares yourself, the company will mail you a check. If you participate in a DRIP (Dividend ReInvestment Plan, see article on DRIPs elsewhere in this FAQ) and elect to reinvest the dividend, you will have the dividend credited to your DRIP account and purchase shares, and if your stock is held by your broker for you, the broker will receive the dividend from the company and credit it to your account.
Dividends on preferred stock work very much like common stock, except they are much more predictable.
- Some Mutual Funds may delay paying their year-end dividend until early January. However, the IRS requires that those dividends be constructively paid at the end of the previous year. So in these cases, you might find that a dividend paid in January was included in the previous year's 1099-DIV.
- Sometime before January 31 of the next year, whoever paid the dividend will send you and the IRS a Form 1099-DIV to help you report this dividend income to the IRS.
- Sometimes -- often with Mutual Funds -- a portion of the dividend might be treated as a non-taxable distribution or as a capital gains distribution. The 1099-DIV will list the Gross Dividends (in line 1a) and will also list any non-taxable and capital gains distributions. Enter the Gross Dividends (line 1a) on Schedule B.
- Subtract the non-taxable distributions as shown on Schedule B and decrease your cost basis in that stock by the amount of non-taxable distributions (but not below a cost basis of zero -- you can deduct non-taxable distributions only while the running cost basis is positive.) Deduct the capital gains distributions as shown on Schedule B, and then add them back in on Schedule D if you file Schedule D, else on the front of Form 1040.
Finally, just a bit of accounting information. Earnings are always calculated first, and then the directors of a company decide what to do with those earnings. They can distribute the earnings to the stockholders in the form of dividends, retain the earnings, or take the money and head for Brazil (NB: the last option tends to make the stockholders angry and get the local district attorney on the case :-). Utilities and seasonal companies often pay out dividends that exceed earnings - this tends to prop up the stock price nicely - but of course no company can do that year after year
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