Non-Taxable Distribution Definition

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Non-Taxable Distribution Definition

What Is a Non-Taxable Distribution?

A payout to shareholders is a non-taxable distribution. It is comparable to a dividend in that it reflects a portion of a company’s capital rather than profits. Contrary to what the name implies, it is not really non-taxable. It’s only that it’s not taxed until the investor sells shares in the firm that made the payout. Non-taxable dividends lower the stock’s basis.

Stock obtained as a non-taxable payout from a company spinoff may be transferred to investors. Non-taxable distributions are dividends given to cash-value life insurance policyholders.

Non-taxable distributions are also known as non-dividend distributions or capital distributions.

Key Takeaways

  • A stock dividend, a stock split, or a payout from a company liquidation are all examples of non-taxable distributions.
  • When you sell the shares of the company that made the dividend, the non-taxable payout becomes taxable.
  • The non-taxable payout is reported to the IRS as a decrease in the stock’s cost basis.

Understanding Non-Taxable Distributions

A non-taxable dividend to shareholders is not paid from a company’s or mutual fund’s earnings or profits. It is a capital return, which means that investors are receiving part of the money they put in the firm back.

Non-taxable payments include stock dividends, stock splits, stock rights, and payouts earned following a corporation’s partial or total liquidation.

The distribution is not taxable when it is made, but it is taxable when the stock is sold. Non-taxable dividends require shareholders to lower the cost basis of their shares. When the shareholder sells the shares, the capital gain or loss is determined using the adjusted basis.

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For example, suppose an investor pays $800 for 100 shares of a firm. The investor gets a non-taxable payout of $90 from the corporation throughout the tax year. The cost base will be set at $710. (the price paid for the shares minus the distribution).The investor sells the shares for $1,000 the next year. The investor’s capital gain for tax purposes is $290 (the $200 profit plus the $90 payout).

A non-dividend payout is often less than the investor’s basis in the shares. In the rare instance when the payout exceeds the basis, the shareholder must lower their cost basis to zero and declare the excess as a capital gain on IRS Form Schedule D.

Assume the investor in the above example gets a total of $890 in non-taxable dividends. The first $800 of the payout will result in a zero cost basis. The remaining $90 must be declared as either a short-term or long-term capital gain, depending on whether the shares were held for more than a year.

Non-taxable dividends are typically reported on Form 1099-DIV under Box 3. The return of capital appears in the form’s “Non-Dividend Distributions” column. This document may be obtained by the investor from the firm that paid the dividend. If this is not the case, the payout may be recorded as an ordinary dividend. Investors may find full information regarding the reporting requirements for investment income, including non-dividend distribution income, in IRS Publication 550.

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