What Happens to Retained Earnings When a Dividend Is Paid?
A cash dividend distributes some of a company's profits to shareholders, with the decision to do so made by the board of directors. A company's net profit appears in the retained earnings on the balance sheet. There are tax consequences for the receiver of dividends, a consideration for both the board of directors and individual shareholder. The corporation pays taxes on profits and the shareholder pays taxes on the dividends paid.
Other People Are Reading
-
Accounting
-
Dividends paid to shareholders get tracked in a company's statement of cash flows and statement of changes in stockholders’ equity. Dividends paid do not change the income for the company but lower the retained earnings subsection of owners’ equity on the balance sheet. As explained by Kenneth Meunier on his Business Accounting Guides website, net income and reorganizations add to retained earnings. The distribution of dividends, a net loss and some Treasury stock transactions decrease retained earnings. Payment of stock dividends does reduce retained earnings, but it normally does not impact the tax liability of the company.
Dividends and Taxes
-
Investors should always check with a competent tax accountant. When a company pays a dividend, it must send a 1099-DIV to the shareholder at the end of the year. This form shows whether the dividends are qualified or non-qualified, which have different tax treatments. A cash dividend is qualified if the shareholder held the stock for at least 60 of the 121-day period starting 60 days before the ex-dividend date. If qualified, the maximum tax rate on the dividends is 15 percent. A non-qualified dividend is taxable at the shareholder's income tax rate.
-
Retained Earnings
-
Retained earnings reflect the net earnings kept by the company to help future expansion and growth. Retained earnings are also known as the retention ratio and retained surplus. Retained earnings are found under shareholders' equity on the balance sheet and are an accumulation of earnings and losses from the start of business. Retained earnings are offset by net losses in income and by the payment of a dividend. Dividends are generally paid by well-established companies with a consistent track record of earnings. Growth companies, those seeing large gains in earnings, often take profits and reinvest them to keep growth strong. Once a plateau has been reached in growth, a company often starts paying dividends.
Decisions
-
The board of directors makes the decision on what to do with the profits made by the company. Net profits are added to retained earnings, but this doesn't mean they have to be paid out as dividends. Some directors would rather put earnings back into the business to expand growth. This, in turn, raises the price of the stock and provides gains for shareholders through appreciation. Well-established companies, also known as blue chips, tend to pay dividends out of their retained earnings, which exceed the capital needed to expand operations.
-
References
- Photo Credit Thinkstock/Comstock/Getty Images Comstock/Comstock/Getty Images
