What is the double taxation of dividends?

By Investopedia Staff AAA
A:

After all is said and done, companies that have made a profit can do one of two things with the excess cash. They can (1) take the money and reinvest it to earn even more money, or (2) take the excess funds and divide them among the company's owners, the shareholders, in the form of a dividend.

If the company decides to pay out dividends, the earnings are taxed twice by the government because of the transfer of the money from the company to the shareholders. The first taxation occurs at the company's year-end when it must pay taxes on its earnings. The second taxation occurs when the shareholders receive the dividends, which come from the company's after-tax earnings. The shareholders pay taxes first as owners of a company that brings in earnings and then again as individuals, who must pay income taxes on their own personal dividend earnings.

This may not seem like a big deal to some people who don't really earn substantial amounts of dividend income, but it does bother those whose dividend earnings are larger. Consider this: you work all week and get a paycheck from which tax is deducted. After arriving home, you give your children their weekly allowances, and then an IRS representative shows up at your front door to take a portion of the money you give to your kids. You would complain since you already paid taxes on the money you earned, but in the context of dividend payouts double taxation of earnings is legal.

The double taxation also poses a dilemma to CEOs of companies when deciding whether to reinvest the company's earnings internally. Because the government takes two bites out of the money paid as dividends, it may seem more logical for the company to reinvest the money into projects that may instead give shareholders earnings in capital gains. (For more on this subject, check out Dividend Tax Rates: What Investors Need To Know and Dividend Facts You May Not Know.)

RELATED FAQS

  1. Are stock dividends and stock splits taxed?

    Understand different tax implications for dividend payments and stock splits; main factors include the type of account and ...
  2. How is revenue related to retained earnings?

    Learn what business revenue is and how it relates to retained earnings. See how accountants calculate these key figures and ...
  3. What aids will help me file my own tax return?

    Most of us will shy away from doing our own tax returns, especially if it involves reporting capital gains or losses, education ...
  4. What is the difference between preferred stock and common stock?

    Preferred and common stocks are different in two key aspects. First, preferred stockholders have a greater claim to a company's ...
RELATED TERMS
  1. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  2. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  3. Variable Annuitization

    An annuity option in which the amount of income payments received ...
  4. Peter Pan Syndrome

    A regulatory environment in which firms prefer to stay small ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
comments powered by Disqus
Related Articles
  1. Federal Tax Brackets
    Taxes

    Federal Tax Brackets

  2. What You Need To Know About Preferred ...
    Trading Strategies

    What You Need To Know About Preferred ...

  3. Technology Dividends Offer Income Opportunity
    Investing News

    Technology Dividends Offer Income Opportunity

  4. After-Tax Balance Rules For Retirement ...
    Taxes

    After-Tax Balance Rules For Retirement ...

  5. Changes In Tax Legislation And Regulation
    Taxes

    Changes In Tax Legislation And Regulation

Trading Center