What are Dividends?

Some items that you might think of as interest are treated by the IRS as dividends, and vice versa. For example, distributions by money market mutual funds are considered "dividends," but ordinary distributions by tax-free municipal bond mutual funds are treated as "interest."

As of 1998, "ordinary dividends" you received from mutual funds reported in Box 1 of the 1099-DIV do not include the amount of any long-term capital gains distributions (i.e., net gains from sales of securities by the fund, which are passed through to the shareholders). Instead, your total long-term capital gain distributions are included in Box 2a, with more specific types of capital gain shown in Box 2b, 2c, 2d, and 2e. You then report these amounts directly on Schedule D, Capital Gains and Losses, Line 13, or to one of the worksheets indicated in the instructions to Schedule D. This allows you to more easily compute your tax at the special, lower long-term capital gains rate on Schedule D.

You must report and pay tax on the gross amount of all the ordinary dividends you were entitled to receive, even if you never actually received them because you reinvested them through a common-stock dividend reinvestment plan (DRIP) or a mutual fund reinvestment plan. If you paid any commissions or fees for reinvesting, you may be able to deduct them as investment expenses.

Save Money If you do reinvest dividends, make sure that you keep track of them by saving the annual statements on which they are reported. If you keep good records, when you sell the investment, you'll be able to add the reinvested amounts to your basis in the investment, and pay less in capital gains tax. If you lose your records, in some cases the issuer of the stock or mutual fund will be able to tell you what your reinvestments were, but they might not be able to locate records that go back as far as you need.

If you sold stock after a dividend was declared, but before it was paid, you are still treated as having received the dividend, and you must pay tax on it.