What is the double taxation of dividends?

Sort By:
Most Helpful
November 2016
83% of people found this answer helpful

First, let's understand what a dividend is. When a corporation makes a profit, it pays income tax on that profit, similar to the way individuals pay income tax on their wages and other income.What's left after the corporation pays income tax is known as "profit after tax" (PAT). A corporation with PAT can do two things with their PAT: (1) It can retain it in the business and either hold it as a reserve or invest it in new plant, equipment, R&D, etc.; and/or (2) It can distribute it to its shareholders. Such distributions are called "dividends." (Note: corporations with a history of profitability may choose to pay dividends even when the company is temporarily not earning profits.)

Apple Inc. earns huge PAT. The company has about 5.39 billion shares outstanding and currently pays $2.28 per share, per year in dividends to its shareholders. That amounts to about $12.3 billion in annual dividends paid, or roughly one-quarter of its PAT. If you are a shareholder of, say, 100 shares of Apple (symbol: AAPL), you receive $228 in dividends a year. You must report those dividends as income on your tax return. Depending on your tax bracket, you may pay tax on the dividends of as much as 20% of the $228, as well as state income tax, if applicable.

Because Apple paid tax on its profits, and then you paid tax on the dividends, some refer to this as double taxation of dividends. In fact, it is double taxation of corporate profits; the dividend itself is only taxed once. In order to avoid double taxation, some companies (for example, Berkshire Hathaway) choose not to pay a dividend. But many investors desire the steady income that dividends can provide.

February 2005