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Dividends 101

The Definition of a Dividend     
A dividend is a payment made by a company to its shareholders, usually on a quarterly basis. Companies are not required to issue dividends, but many do so as an incentive for shareholders to own stock in their businesses. When issuing a dividend, a company distributes a percentage of its profits among shareholders, often in the form of a check or cash deposit. Shareholders pay taxes on their dividend income according to their respective tax brackets. Who invests in dividend-paying companies?

Millions of Americans, from all income levels and age groups, own stocks that pay dividends. Seniors and people reaching retirement age, in particular, represent a large portion of investors who own dividend-paying stocks. In fact, many seniors rely on dividends as a way to supplement their retirement income. According to a January 2010 study by Ernst & Young, 27.1 million tax returns had dividends qualifying for the dividend tax rate reduction in 2007 (the latest year for which complete IRS data are available). Of these tax returns, 61 percent were from taxpayers age 50 and older and 30 percent were from taxpayers age 65 and older.

How do I find out which companies pay dividends?

Searching for dividend-paying stocks is easy. If you already use an investment firm to manage your money, they'll likely have an online search tool to help you pick out stocks that pay dividends. Otherwise, Web sites like MSN Money and Google Finance have free "stock screeners" that allow you to perform custom searches for dividend-paying stocks.

Using these tools, you also can try searching by industries that traditionally pay dividends. Electric and natural gas companies have a long history of paying dividends to their shareholders and typically pay out the highest percentage of earnings among all U.S. business sectors.

How do I know if I own dividend-paying stocks?

Ask your broker. Alternatively, you can review your investment account balance online; or check your mailed statement. If you see a periodic deposit from a company whose stock you own, it's most likely a dividend payment. To be sure, visit the company's Web site. Almost every shareholder-owned company has a Web page dedicated to investors, where dividend information can be found. Online stock screeners also are a good way to verify whether your stocks pay dividends.

Who benefits from lower dividend tax rates?
There is a perception that lower dividend tax rates benefit only wealthy taxpayers. But that just isn't the case. Millions of Americans—from all income levels and age groups—own stocks that pay dividends. Lower dividend tax rates don't just benefit direct shareholders. They also benefit the tens of millions of Americans who own stocks indirectly through mutual funds, and they support the value of stocks held through or in life insurance policies, IRAs, pension funds, or 401(k) plans. Additionally, lower dividend tax rates benefit Americans who own no stocks or mutual funds by helping to spur the growth that is needed to create new jobs and to strengthen the economy. Coming off of the recent economic downturn, lower dividend tax rates have helped to attract and to keep shareholders who are interested in a more long-term buy and hold strategy, which benefits individual shareholders, companies, and, ultimately, the economy.

You and Your Dividend

How do shareholders benefit from dividends?

For millions of shareholders, especially retirees, dividends provide a regular source of income. Even if you don't rely on dividends for current income, they can be a powerful investment tool to help you generate wealth over the long term. Regular dividend payments add up over time, which then can be reinvested in stocks or other types of equities.

In addition, dividend-paying companies that experience solid, year-upon-year growth, often raise the percentage of money that they pay out to their shareholders, called a "dividend yield." A stronger dividend yield means more money in your pocket, and often can raise the perceived value of your company's stock.

Most important, taxpayers in the 10- or 15-percent tax brackets currently pay no taxes on their dividend income. For all other taxpayers, the tax rate on dividend income is capped at 15 percent. Unless Congress acts to stop an impending dividend tax hike, the current rates expire on December 31, 2010. This means that the taxes you pay on dividend income could spike—as much as 164 percent over current levels.

The Dividend Tax Rate Reduction
In 2003, Congress passed an important law—the Jobs and Growth Tax Reconciliation Act of 2003—that temporarily reduced the maximum tax rate on dividend income from almost 40 percent to 15 percent. Taxpayers in the 10- or 15-percent tax brackets currently pay no taxes on their dividend income. The 2003 law also reduced the maximum rate on capital gains from 20 percent to 15 percent.
The 2003 tax cuts are scheduled to expire on December 31, 2010, unless Congress acts. This means the maximum tax rate on dividend income will surge by 164 percent - from 15 percent to 39.6 percent. The maximum tax rate on capital gains will revert to 20 percent. In addition, the recently passed health care legislation imposes an additional 3.8 percent Medicare tax on all investment income beginning in 2013 for households earning more than $200,000 (single)/$250,000 (married).

Lower Dividend Tax Rates: How Do Companies Benefit?
Lower dividend tax rates are good for investors, consumers, American businesses, and the recovering U.S. economy. They make dividend-paying companies—like electric and natural gas companies—more attractive to investors. And by attracting new investment in their shares, these companies are able to raise the capital they need to fund major infrastructure investment projects. These capital investment programs offer an important source of much-needed, high-quality job creation in many states.
For the utility sector, the continuation of the dividend tax rate reduction is necessary for long-term planning. Should the dividend tax rate reduction expire, tax policy would revert to favoring debt over equity in order to raise capital—an outcome that could make investors hesitant to provide financing for major new projects and disrupt companies' ability to implement long-term strategic plans to meet customer demands.

Electric and Natural Gas Companies and Dividends
The payment of dividends is an important way for companies to provide a return on capital to investors and to attract new shareholders. In the utility sector, lower dividend tax rates helped to reverse an overall decline in the percentage of electric companies that pay a dividend. In 2009, U.S. shareholder-owned electric and natural gas companies paid out $18.5 billion in dividends to investors. This sector typically pays out the highest percentage of earnings among all U.S. business sectors. What's more, Ernst & Young analyzed shareholders who directly own stocks in electric and natural gas companies and found that 86 percent of tax returns with qualified dividends were from taxpayers age 50 and older and 59 percent were from taxpayers age 65 and older.

Electric and natural gas companies are among the most capital-intensive industries in the world. Having access to a steady stream of capital allows these companies to modernize and to build new, cleaner generating capacity; to invest in major transmission and distribution system upgrades; and to make additional environmental and energy-efficiency improvements.

Where We Stand Today
Extended in 2006, the dividend tax rate reduction is scheduled to expire on December 31, 2010. For the millions of Americans who currently receive dividends from their investments, this means that the taxes they pay on this income could skyrocket unless Congress acts to stop a dividend tax hike.

As the nation tries to recover from one of the worst economic periods since the Great Depression, now is not the time to discourage Americans from investing in dividend-paying companies by raising their taxes on dividend income. Instead, Congress should encourage long-term investment in our nation's economy and future by taking action to stop a dividend tax hike for all of us.

What You Can Do to Help
Join our cause! Use this site to learn more about the benefits of the dividend tax rate reduction, and send a letter asking your Members of Congress to stop a dividend tax hike!