Buying common stock can provide a way to gain capital appreciation over the long term, and one of the bonuses of common stock ownership often is receiving a dividend. Companies must pay dividends to preferred stockholders, and although companies are not required to pay dividends to common stockholders, many common stockholders also receive dividends. People often invest in stocks that pay regular dividends to create a source of passive income.
With most publicly traded companies, there are at least two classes of stock -- preferred shares or common shares. Preferred stockholders typically receive a guaranteed dividend, but the value of the shares does not fluctuate much with market conditions. Common stockholders can receive dividends when a company makes a profit, although the company is not obligated to issue these dividends. If dividends are not paid to preferred stockholders on time, they accumulate and are paid at a later date. Common stockholders have no such provision for their dividends.
When a company makes a substantial amount of profit, it may elect to distribute a dividend to the shareholders of the company. The Board of Directors of the company is in charge of determining the dividend amount to be distributed and when it will be issued. The declaration date is the day on which a dividend is announced. The date of record is the day by which the stockholder must own the stock to receive the dividend payment. The money is distributed on the payment date.
When you receive dividends from common stock, you incur a tax liability. The money distributed through dividends has already been taxed at the corporate level, which creates a double-taxation scenario. If the dividend is issued by an American company and you hold it for longer than 60 days, the dividend probably will count as a qualified dividend. In this case, you can pay a lower tax rate than your regular marginal tax rate.
Many individuals in retirement use common stock dividends to create passive income. Investing in larger companies that do not tend to reinvest the majority of their profits back into the company could provide you a means to earn a regular dividend. These larger companies may elect to pay dividends every quarter out of the profits generated through business operations. This is profit that can be taken without having to sell the shares of common stock.