Income and Assets · Income

Dividends and other distributions from mutual funds, corporations, and other entities

Verification 2026 Verified
tax year · reviewed 2026-08-19 · Draft for I. Ohu review

Two questions decide the tax on a distribution, and the statements clients bring rarely answer either one reliably. Is it a dividend at all — which depends on the payer’s earnings and profits, not on what the payment is called? And if it is, is it a qualified dividend — which depends on how long the shareholder held the stock, something no payer can know. Both determinations are made by someone without the facts, and both are worth checking.

The rule

A dividend is a distribution out of earnings and profits. The term means any distribution of property made by a corporation to its shareholders out of earnings and profits accumulated after 28 February 1913, or out of the earnings and profits of the taxable year computed at the close of that year without reduction for distributions made during it (IRC § 316(a)(1), (2)). The section then adds a presumption that carries most of the practical weight: except as otherwise provided, every distribution is made out of earnings and profits to the extent of them, and from the most recently accumulated.

What is not a dividend falls through two more tiers. The portion of a distribution that is a dividend is included in gross income; the portion that is not is applied against and reduces the adjusted basis of the stock; and any remainder is treated as gain from the sale or exchange of property (IRC § 301(c)(1)–(3)). A distribution can therefore be partly ordinary income, partly a tax-free return of capital, and partly capital gain in a single payment.

Qualified dividend status is about the shareholder, not the payer. Qualified dividend income means dividends received from domestic corporations and qualified foreign corporations (IRC § 1(h)(11)(B)(i)), excluding dividends from § 501 and § 521 exempt organisations, § 591 amounts and § 404(k) dividends (IRC § 1(h)(11)(B)(ii)). The holding period is imported: the term excludes any dividend on stock for which the § 246(c) requirements are not met, substituting “60 days” for “45 days” and “121-day period” for “91-day period” (IRC § 1(h)(11)(B)(iii)(I)). Read together with § 246(c)(1)(A), that means the stock must be held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date, counting the day of disposition but not the day of acquisition (IRC § 246(c)(3)(A)). Preference stock with dividends attributable to a period exceeding 366 days uses a longer pair of figures (IRC § 246(c)(2)). Being under an obligation to make related payments on substantially similar property also disqualifies (IRC § 1(h)(11)(B)(iii)(II)).

Fund distributions are three different things. A capital gain dividend is treated by shareholders as gain from the sale or exchange of a capital asset held for more than one year (IRC § 852(b)(3)(B)), and it is defined by what the company reports in written statements to shareholders (IRC § 852(b)(3)(C)(i)) — so the fund’s designation controls. A capital gain dividend is expressly not considered a dividend for § 1(h)(11) purposes (IRC § 854(a)). An exempt-interest dividend is excluded from gross income but still reported, and carries its private activity share into the minimum tax.

Stock dividends are usually not income. Gross income does not include a distribution by a corporation of its own stock to its shareholders with respect to its stock (IRC § 305(a)) — unless one of the § 305(b) exceptions applies, the first of which is a distribution payable at the election of any shareholder in stock or in property (IRC § 305(b)(1)), which brings § 301 into play. That is the provision standing behind the treatment of dividend reinvestment plans.

Two further layers sit on top. Qualified REIT dividends are not qualified dividend income, but twenty percent of them enters the combined qualified business income amount without any wage or property limitation (IRC § 199A(b)(1)(B)). And dividends are net investment income, reached by a separate tax on the lesser of net investment income or the excess of modified adjusted gross income over an unindexed threshold (IRC § 1411(a)(1), (b)).

Current figures

Item	2026
Qualified dividend holding period	more than 60 days during the 121-day period beginning 60 days before the ex-dividend date, counting the day of disposition but not the day of acquisition; more than 90 days in a 181-day period for preferred stock dividends attributable to a period exceeding 366 days^TY2026
Net investment income tax	3.8 percent of the lesser of net investment income or the excess of modified adjusted gross income over $250,000 on a joint return, $125,000 for a married individual filing separately, and $200,000 in any other case — none of the thresholds indexed^TY2026
Dividend reporting threshold	$10 or more of dividends paid to any person in a calendar year, and the same for a nominee passing dividends on^TY2026
Qualified REIT dividends in the QBI computation	20 percent of the aggregate of qualified REIT dividends and qualified publicly traded partnership income, added to the combined qualified business income amount without any wage or property limitation^TY2026

How it works in practice

Read the statement as a set of claims to be tested, not as an answer. The qualified dividend figure on it is the payer’s or broker’s best guess: they know the ex-dividend dates but not whether the client sold shortly after one. A client who trades around distributions will have a reported qualified figure that is too high, and the correction is the client’s to make.

Where the shares came from a corporation with no current or accumulated earnings and profits — a closely held company after a bad year is the usual case — the § 301(c) tiers do real work. Test the distribution against earnings and profits first, then run the excess against basis, then treat what is left as gain. Getting this wrong in the client’s favour understates income; getting it wrong the other way taxes a return of capital.

For funds, keep the three categories apart. Ordinary dividends may or may not be qualified; capital gain dividends are long-term regardless of how long the client held the fund shares, which is the single most useful fact in this topic; exempt-interest dividends stay out of gross income but come back for the minimum tax and for the social security formula.

Two administrative habits. Check whether a client participates in a reinvestment plan, because reinvested dividends are taxed as received and each reinvestment starts a new lot with its own basis and holding period — a records problem that compounds silently for years. And where a plan offers shares at a discount, the discount is itself income, with basis taken at full fair market value.

The distribution that was not a dividend

Kwame owns shares in a small operating company. It distributed $30,000 to him during a year in which it had no current earnings and profits and accumulated earnings and profits of $12,000. His basis in the shares is $9,000.

The distribution splits three ways under IRC § 301(c). The first $12,000 is a dividend out of accumulated earnings and profits (IRC § 316(a)(1)) and is ordinary income. The next $9,000 is not a dividend, so it is applied against and reduces his basis to zero (IRC § 301(c)(2)). The remaining $9,000 exceeds his basis and is treated as gain from the sale or exchange of property (IRC § 301(c)(3)(A)).

The company’s own statement is likely to report the whole $30,000 as an ordinary dividend, because the earnings and profits computation is not one it makes for the payee. The character difference here is worth several thousand dollars in tax.

Sold too soon after the ex-dividend date

Ines bought 800 shares on 20 May. The ex-dividend date was 10 June and she received $1,400 of ordinary dividends. She sold the whole position on 15 July, and her broker reports the full $1,400 as qualified.

It is not qualified. The 121-day period begins 60 days before the ex-dividend date, so it runs from 11 April, and within it she must hold the stock for more than 60 days. Counting the day of disposition but not the day of acquisition (IRC § 246(c)(3)(A)), she held from 21 May to 15 July, which is 56 days. Short by five.

Had she held to 20 July, giving 61 days, she would have been over the line and the whole $1,400 would have qualified. The broker’s figure is not wrong through carelessness — it simply cannot see her disposition against each ex-dividend date, so the adjustment is hers.

The reinvestment plan discount

Toma participates in a plan that lets him buy shares at $20 when the market price on the dividend payment date is $22. He buys 100 shares.

He has $200 of income. The plan is within IRC § 305(b)(1) — a distribution payable at the election of a shareholder in stock or in property — so § 301 applies rather than the § 305(a) exclusion, and the discount is the measure of what he received. Publication 550 states the same result and adds the part clients miss: his basis is the full fair market value, $2,200, not the $2,000 he paid.

Missing the basis point is the expensive half. A client who records basis at cost pays tax on the discount now and pays tax on the same $200 again as gain when the shares are sold.

Traps

Not every distribution is a dividend. IRC § 316 limits the term to distributions out of earnings and profits, and IRC § 301(c) routes the rest to basis and then to gain.
The presumption runs the other way, though. Every distribution is presumed made out of earnings and profits to the extent of them, from the most recently accumulated (IRC § 316(a)).
The reported qualified dividend figure is a guess about the payee. Only the client’s holding period settles it.
The holding period is “more than 60 days”, not 60, and the day of acquisition is not counted (IRC § 246(c)(3)(A)).
The 121-day period starts 60 days before the ex-dividend date, so roughly half of it precedes the dividend.
Preference stock uses different figures where the dividends are attributable to a period over 366 days (IRC § 246(c)(2)).
A capital gain dividend is long-term however briefly the fund shares were held (IRC § 852(b)(3)(B)), and is not a dividend for qualified dividend purposes (IRC § 854(a)).
The fund’s written designation controls what is a capital gain dividend (IRC § 852(b)(3)(C)(i)).
REIT dividends are generally not qualified dividends, but they carry a share of the § 199A deduction (IRC § 199A(b)(1)(B)).
Reinvested dividends are taxed as received, and each reinvestment is a new lot with its own basis and holding period.
A reinvestment plan discount is income and basis is full fair market value, so recording basis at cost taxes the same amount twice.
The IRC § 1411 thresholds are not indexed, so more clients cross them every year without any change in the law.

How this has changed

The architecture here is old, and almost none of it moves annually. What repays attention is which figures are frozen and which are not, because the pattern is the reverse of what the rest of the return teaches. The § 246(c) day counts are statutory. The § 6042 reporting threshold is statutory. Most importantly the § 1411 thresholds are statutory and not indexed, so the net investment income tax reaches steadily further each year purely through nominal income growth — a change in effect with no change in text.

The one moving part worth watching is the qualified dividend rate structure, which is not in this section at all: qualified dividend income is folded into net capital gain by IRC § 1(h)(11)(A) and taxed under the capital gain rate brackets, and those brackets are adjusted annually. So a client’s qualified dividends can change in tax without changing in character or amount.

Where currency does bite is in the interaction with § 199A. Qualified REIT dividends earn their share of the deduction through § 199A(b)(1)(B), and the deduction’s own thresholds and limitations are adjusted each year — so the value of holding a REIT rather than an operating company through a fund is an annual question rather than a settled one.

Exam focus

Know the § 301(c) ordering cold: dividend to the extent of earnings and profits, then against basis, then gain. Expect a question that supplies both earnings and profits and basis and asks for the three-way split.

Know the qualified dividend holding period exactly, including that the window opens 60 days before the ex-dividend date and that the requirement is more than 60 days within it. Expect the arithmetic to be the whole question.

Know that a capital gain dividend from a fund is long-term regardless of the shareholder’s holding period, and that § 854(a) keeps it out of qualified dividend income.

Finally, know that § 305(a) excludes stock dividends but § 305(b)(1) pulls in anything electively payable in stock or property — the provision behind reinvestment plans.

Check yourself

1. A corporation with $20,000 of accumulated earnings and profits and no current earnings and profits distributes $50,000 to a sole shareholder whose basis is $18,000. How is it characterised?

Answer: $20,000 is a dividend included in gross income (IRC § 316(a)(1), § 301(c)(1)); $18,000 is applied against and reduces basis to zero (IRC § 301(c)(2)); and the remaining $12,000 is treated as gain from the sale or exchange of property (IRC § 301(c)(3)(A)).

2. A shareholder buys stock on 1 March, the ex-dividend date is 20 March, and she sells on 10 May. Are the dividends qualified?

Answer: yes. The 121-day period begins 60 days before 20 March, so on 19 January. Counting from 2 March — the day of acquisition is excluded under IRC § 246(c)(3)(A) — to the 10 May disposition is 70 days, which is more than the 60 days required by IRC § 1(h)(11)(B)(iii)(I) as it applies § 246(c).

3. A client bought fund shares in November and received a capital gain dividend in December. Is the gain short-term?

Answer: no. IRC § 852(b)(3)(B) provides that a capital gain dividend is treated by shareholders as gain from the sale or exchange of a capital asset held for more than one year, whatever the shareholder’s actual holding period in the fund shares. IRC § 854(a) separately keeps it out of qualified dividend income.

4. Why can a taxpayer’s own qualified dividend figure differ from the one the broker reports?

Answer: because the test in IRC § 1(h)(11)(B)(iii) is applied to the shareholder’s holding period against each ex-dividend date, and the broker cannot always see whether a disposition broke it. The reported figure is a starting point; where the client sold within the window the qualified amount must be reduced on the return.

Change log

2026-08-19Initial draft. Sets out the IRC § 316 earnings and profits test, the IRC § 301(c) three-tier ordering, the IRC § 1(h)(11) qualified dividend holding period as it borrows from IRC § 246(c), and the treatment of regulated investment company and REIT distributions.