What Is a Spillover Dividend?
A spillover dividend is a dividend that is announced in one year but counted as part of another year's income for federal tax purposes. This often happens when a dividend is announced near the end of the calendar year. A company might state in December 2020, for instance, that shareholders of record will receive a dividend. The actual payment of the dividend might not occur until January or February of 2021. In these cases, the dividend would count as taxable income in the year that it was declared, not the year in which it was paid.
A spillover dividend may also be known as a throwback dividend.
- A spillover dividend is announced in one year but paid in another.
- Investors pay taxes on the dividend the year it is announced, not the year they are paid the dividend.
- For certain business entities, the rules around spillover dividends are more complex.
- Spillover dividends are most common among regulated investment companies (RICs).
Understanding the Spillover Dividend
A spillover dividend might “spill over” into the next year in terms of payment to shareholders, but in terms of taxes, that liability would remain in the year that the dividend was announced. For example, ABC Trust, a unit investment trust, declares that shareholders of record on Dec. 15, 2020, are entitled to receive a $2 dividend on each share of ABC Trust units that they own, with a payment date of Jan. 25, 2021. For Internal Revenue Service (IRS) purposes, the shareholders would need to include the $2-per-share dividend when they file their annual tax return for 2020.
For most taxpayers, this is not an issue, since they have the dividend in hand by the time they pay their taxes for the year.
The Typica Dividend Process
The ordinary process of setting and paying dividends is subject not only to a corporation's discretion, but also to the rules of the respective stock exchange on which the stock is listed. There are four important dates related to dividends:
- Declaration date or announcement date.
- Ex-dividend date.
- Record date or holder of record date.
- Payment date.
The declaration date is when the dividend is announced. The ex-dividend date means anyone who buys the stock on or after the ex-dividend date is not entitled to the declared dividend. The record date is usually the day after the dividend date and is when the company records who gets the dividend. The payment date is when the actual dividend is paid to eligible shareholders.
On the ex-dividend date, the stock price theoretically should drop by the amount of the dividend, since the company will be allocating that amount to be distributed to shareholders. For example, if a company has declared a $1 dividend, on the ex-dividend day the stock should theoretically open $1 less than the prior close. In the real world, this doesn't always happen because there are multiple factors that affect the stock price.
Exceptions to Spillover Dividend Tax Rules
For some types of entities, the tax rules for spillover dividends are more complicated. For registered investment companies (RICs)—such as mutual funds or real estate investment trusts (REITs), or companies that are taxed like them, such as business development companies (BDCs)—United States law says that spillover dividends must be declared by the 15th day of the ninth month after the end of the taxable year.
Also, shareholders are usually taxed on dividends in the year when the actual payment of these dividends takes place. The due date for a RIC to file its tax return is the 15th day of the third month in the next financial year. A qualifying company may obtain an automatic six-month filing extension if its Form-7004 is filed before the tax return's due date.
Because RICs usually do make use of the six-month extension, it means that effectively RICs have the option to declare spillover dividends as taxable income by nine-and-a-half months after the present taxable year.
Example of a Spillover Dividend
In any given year, a spillover dividend could end up looking like the graphic below.
A RIC declares a dividend in October. The ex-dividend date is set for Dec. 14. Anyone who wants the dividend must own the stock before the ex-dividend date. Effectively, ex-dividend means no dividend for people buying the stock that day. The record date is for the RIC, and not of much interest to the investor. In this case though, because the dividend is occurring near the end of the year, the payment date is not till January.
For tax purposes, the dividend must be included on the investor's tax return for this year, even though they won't actually receive the dividend payment until next year.