Dividends and Capital Gains

Written By Ethan Yan

Dividends vs Capital Gains

Both of these terms are the result of making money from the shares you own. They primarily differ from how you’re getting the money. By definition, Dividends are profits paid out from a corporation to a stockholder, while Capital Gains are an increase in value of the stock, where you have to sell the stock to make profit.

Dividend Income

The key difference between dividends and capital gains is that you don’t sell your shares to gain profit. Instead, the corporation pays it out to you and is considered as income for that tax year. The payment period can vary from monthly, quarterly, or yearly. Either way, it’s decided by the board of directors.

There are two subcategories of dividends: Ordinary and Qualified. Something to note is that dividends from a tax-advantaged account, like an IRA, 401(k), or HSA don’t pay income taxes when dividends are issued.

Qualified

  • Shares that are held for more than 60 days are labeled as qualified dividends. If you’re unsure if it’s qualified, your brokerage firm will send a 1099-DIV form, it should be box 1b if it is qualified.

  • They are taxed at a long-term capital gains rates rather than your ordinary income tax rate. Their rates are 0%, 15%, or 20% at the federal level.

Ordinary

  • Stock shares that are held for less than 60 days are labeled as ordinary dividends. On your 1099-DIV form, it should be in box 1a.

  • They are taxed as regular income/ordinary income, which can be up to 37%.

  • Keep in mind, dividends are paid out when the board of directors decide to, so your dividends may typically be ordinary.

Capital gains

Capital gains occur when you sell an asset, like a stock. The distinction is that the asset has to be sold at a profit, otherwise it is considered a capital loss. Just like dividends, there are two categories of capital gains: Short-Term Gains and Long-Term Gains.

Long-term

  • They are taxed as long-term capital gains rates: 0%, 15%, 20%. The rates vary depending on your filing status.

  • They are qualified as long-term when the asset is held for more than a year and sold at a profit.

Short-Term

  • They are taxed as short-term capital gains tax rates, which is your ordinary income tax.

  • Any asset that is held for a year or less and sold at a profit is labeled as a short-term capital gain.

Why two categories?

Qualified Dividends: This category exists because it’s primary role is to reduce double taxation of corporate profits. C Corporations are taxed at the corporate level and again as investor income. To make their shares more attractive to investors, the JGTRRA of 2003 was enacted. It benefited investors who held their stocks longer, especially in C Corporations where their dividend returns were less due to double taxation. With JGTRRA, they’re able to have some tax-advantage benefits for their long-term investment.

Long-Term capital gains: The obvious benefit is to reward their investors for holding it long term; which is riskier for the investor as the stock value may drop. However, a corporation wants the investor to hold on to a stock longer as it can stabilize stock price, reduce volatility, and signal market confidence in the corporation.

Ethan Yan
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