Quick Answer
Dividends are profit distributions the board declares at its discretion. Cash dividends are taxed as ordinary or qualified income; stock dividends are not taxed when received but lower cost basis per share. Four dates control who gets paid: declaration, ex-dividend, record, and payment. The stock price typically drops by the dividend amount on the ex-date.
With your understanding of shareholder rights and resale restrictions in place, let's look at the income side of equity ownership. Dividends are distributions of corporate profits to shareholders, but they are not guaranteed.
What Are the Basics of Dividends?
- Dividends are declared by the board of directors; there is no obligation to declare one, though a dividend becomes a corporate liability once declared
- They represent a return of corporate profits to shareholders
- The two main forms are cash dividends and stock dividends
How Do Cash and Stock Dividends Differ?
How Are Cash Dividends Taxed?
- The most common form of dividend
- Paid as a dollar amount per share (e.g., $0.50/share)
- Tax treatment: Taxed as either ordinary income or qualified dividends
- Qualified dividends receive a lower tax rate (0%, 15%, or 20% depending on income bracket)
- To qualify: the stock must be held for more than 60 days during the 121-day period surrounding the ex-dividend date
- Dividends from most U.S. corporations and qualified foreign corporations are eligible
How Are Stock Dividends Taxed?
- Additional shares distributed to existing shareholders (e.g., a 10% stock dividend gives you 1 extra share for every 10 you own)
- Not taxable when received
- Adjusts your cost basis per share: total cost basis stays the same, but it is spread across more shares
- Does not change your proportional ownership
Think of it this way: A stock dividend is like cutting a pizza into more slices. You have more pieces, but the same total amount of pizza. Your cost basis per share drops because you now own more shares, but your total investment value has not changed.
| Feature | Cash Dividend | Stock Dividend |
|---|---|---|
| What you receive | Cash payment | Additional shares |
| Taxable when received? | Yes | No |
| Effect on cost basis | No change | Cost basis per share decreases |
| Effect on ownership % | No change | No change |
| Effect on share price | Drops by dividend amount | Adjusts proportionally |
Exam Tip: Gotchas
- Stock dividends are NOT taxable when received (but cash dividends are). The tax event for stock dividends comes when you eventually sell the shares.
- Stock dividends adjust cost basis per share but do not change total cost basis. Your investment value stays the same; it is just spread across more shares.
What Are the Four Important Dividend Dates?
The dividend timeline is frequently tested. These four dates determine who receives the dividend and when.
| Date | What Happens | Who Sets It |
|---|---|---|
| Declaration date | Board announces the dividend | Board of directors |
| Ex-dividend date | First date a buyer will NOT receive the dividend | The exchange |
| Record date | Shareholders on record receive the dividend | Board of directors |
| Payment date | Dividend is actually paid out | Board of directors |
Memory Aid: D-E-R-P (Declaration, Ex-dividend, Record, Payment). The board Declares, the Exchange sets the ex-date, Record determines eligibility, then Payment goes out. Only the ex-date is set by the exchange; the other three are set by the board.
How Do the Four Dates Work Together?
- Declaration date: The board announces a dividend of $1.00/share, payable on April 15 to shareholders of record on March 31
- Ex-dividend date: Set by the exchange. Under T+1 settlement, the ex-date is the same day as the record date (March 31 in this example) when the record date falls on a business day
- Record date: March 31. You must be a shareholder of record on this date
- Payment date: April 15. Checks go out (or direct deposits hit)
Key rule: If you buy the stock on or after the ex-dividend date, you will not receive the upcoming dividend. You need to buy before the ex-dividend date to receive it.
What Happens to the Stock Price on the Ex-Dividend Date?
The stock price typically drops by the dividend amount on the ex-dividend date. The company's value decreases by the cash being paid out.
- Stock closes at $50 the day before the ex-date
- $1.00 dividend declared
- Stock opens at approximately $49 on the ex-date
Exam Tip: Gotchas
- The ex-dividend date is set by the exchange, not the company. Under T+1 settlement, it is the same day as the record date.
- Buy BEFORE the ex-date to get the dividend. Buying on or after the ex-date means you miss it.
- The stock price drops by the dividend amount on the ex-date. This reflects the cash leaving the company.
What Should You Check on Exam Day?
- Dividends are discretionary before declaration. The board has no obligation to declare one, but a declared dividend becomes a corporate liability.
- Match tax treatment to dividend type: cash dividends are taxed when received; stock dividends are not taxed until sold.
- Know the order and setter of the four dates: declaration and record and payment are set by the board, but the ex-dividend date is set by the exchange.
- Buying on or after the ex-dividend date means you do not receive the upcoming dividend.
- The stock price typically drops by the dividend amount on the ex-date, reflecting cash leaving the company.