Distribution vs Dividend: Key Differences

Dividends are typically associated with stocks and are payments made by a corporation to its shareholders, usually derived from profits. They provide a steady income stream and are often seen as a sign of a company’s financial health. On the other hand, distributions can encompass a broader range of payments, including those from mutual funds, real estate investment trusts (REITs) and limited partnerships. These payments may include income, capital gains, or return of capital, each with distinct tax implications. By distinguishing between distributions and dividends, investors can better align their strategies with their financial goals, ensuring they maximize returns while managing tax liabilities effectively. A financial advisor can provide valuable insight into which type of fixed-income investments are the best fit for your goals, timeline and risk profile.

What Is a Dividend?

Purchasing a share of a stock makes you the partial owner of a corporation. When that happens, you can earn a payment from the company’s profits, known as a dividend. Generally, dividends are the most typical form of cash payment made by C corporations, typically large businesses whose shares trade on major stock exchanges, such as the New York Stock Exchange and the NASDAQ.

Companies may not always choose to pay out dividends. Instead, they can decide to hold on to the money and put it towards something within the company. That way, it has the opportunity to fund internal growth or future operations.

There are also different forms of dividends. Cash dividends are usually the most popular type, but there are also stock dividends, property dividends, scrip dividends and liquidating dividends. The IRS views dividends as separate from the actual share of the company. Instead, the IRS treats it as a portion of the company’s profits. So, dividends don’t factor into the stock’s original cost.

What Is a Distribution?

Unlike a dividend, a distribution is a cash disbursement from a mutual fund or small business that is organized as an S corporation. In the U.S. such corporations can have no more than 100 owners or shareholders, all of whom are U.S. residents. Plus, they can only have a single class of shareholders.

S corporations, which are a type of pass-through entity, forward their income, deductions, losses and credits directly to their shareholders. Those who hold these shares then report the flow-through of income and losses on their own tax returns, where they are assessed at the individual shareholder’s rate. The IRS treats distributions as a payout of company equity and thus is used to calculate the cost basis of an investment.

Distribution vs Dividend: Taxation

Payouts from S Corporations and C corporations are taxed differently. Dividends from C corporations, which file Form 1120 tax returns, are taxed twice. Firstly, the company’s profits are taxed. Secondly, the disbursement of these profits as dividends is made with after-tax money and shareholders who receive these dividends must pay taxes on the dividends they have received. This is known as double taxation.

Sometimes dividends may become eligible as qualified dividends. In this case, they are up for taxation at a lower capital gains rate. Capital gain dividends also break into two categories: long and short-term. Long-term capital gains operate under standard capital gain tax rates. In contrast, short-term capital gains are included under ordinary income.

Generally, S corporations, which file Form 1120-S tax returns (or another form identified with closely held businesses), don’t pay any income taxes. Instead, taxation occurs on the shareholders’ level. So, if you own shares of an S corporation, then you are taxed on your allocated share of the profits from the business, i.e., your distribution.

How to Report Distributions and Dividends

The first step in reporting distributions and dividends is gathering the necessary tax forms. Typically, you will receive a Form 1099-DIV from each financial institution where you hold investments. This form details the total amount of dividends and distributions you received over the year. It’s important to review these forms carefully to ensure all information is accurate.

Understanding the difference between qualified and ordinary dividends is essential for accurate reporting. Qualified dividends are taxed at the lower capital gains tax rate, which can be significantly lower than the rate for ordinary income. To qualify, dividends must be paid by a U.S. corporation or a qualified foreign corporation, and you must meet specific holding period requirements. Ordinary dividends, on the other hand, are taxed at your regular income tax rate. Your Form 1099-DIV will specify which dividends are qualified and which are ordinary, so be sure to report them correctly on your tax return.

Capital gains distributions are another type of income you may need to report. These occur when a mutual fund or other investment vehicle sells securities at a profit and distributes the gains to investors. Like dividends, capital gains distributions are reported on Form 1099-DIV. They are typically taxed at the long-term capital gains rate, which is generally lower than the rate for ordinary income. Accurately reporting these distributions can help you take advantage of potential tax savings.

Distribution vs Dividend: What Is a Yield?

The term “yield” typically refers to the income an investment earns. This is usually expressed as a percentage. Dividend yields are percentages calculated when you divide the overall yearly dividend payments that a shareholder earns by the stock’s current share price. In general, a good dividend yield sits around 2% to 6%, but various factors can sway that number higher or lower. Moreover, those numerous influences can also make it complicated to decide what qualifies as a good dividend yield.

Similarly, a distribution yield also measures the cash payout for a shareholder. For a distribution yield, you annualize the most recent distribution and divide that by the net asset value (NAV) of the investment at the moment of payment.

Several investors purchase stocks from certain companies regardless of increases in their stock price. They are more interested in the companies’ reliable dividend payout and the history of yearly increases that come with it. These corporations are called dividend aristocrats, and they earn a spot on the S&P 500 index for paying and increasing their base dividend annually for a minimum of 25 consecutive years.

By calculating the yields on these Dividend Aristocrats or any valuable investments for distributions, investors can decide which shares are worth purchasing.

Bottom Line

A dividend is a payment from a C corporation, usually in the form of cash or additional shares. A distribution, on the other hand, is a payment from a mutual fund or S corporation, always in the form of cash. Dividends are paid with after-tax money – thus they are double taxed; distributions are paid with before-tax money – thus they avoid being double taxed. The IRS treats distributions as a payout of company equity.

Tips on Investing

If you’re interested in adding dividend income to your investment strategy, you may not know where to start. A financial advisor is one answer to such a dilemma. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
While your main goal may be to find the investment with the strongest dividend yield or distribution yield, it’s important to keep in mind the risk level of every investment. Prioritize your pre-established risk tolerance before looking for specific returns. If you want greater returns or more income, consider reevaluating your portfolio, its strategies and goals first.