A firm can issue dividends to investors who hold ownership stakes (shares) in the firm, or it can issue no dividend or a small dividend to use the cash for other purposes. Dividends provide investors with a share of a firm’s profits on a quarterly or annual basis. While stock dividend issues affect firms and investors negatively from a tax perspective, dividends can have a positive or negative effect on investor returns and company profits.
Publicly traded firms that issue dividends before completing an expansion of their business operations can suffer crippled growth and lost opportunities. If a firm holds onto cash instead of issuing dividends, it has excess capital with which to acquire other firms and a cash cushion to help weather economic downturns. An investor who chooses to buy shares in a growth company that offers dividends will gain short-term profits but sacrifice long-term stock price appreciation.
The issuance of dividends can benefit both a large capitalization firm and an investor if the company has fully penetrated a market and anticipates limited or fixed growth in the future. Since the firm has fewer cash flow needs for expansion and acquisition, it will issue dividends to attract investors who would otherwise switch to growth companies with a higher return. Investors benefit from the receipt of dividends by rolling the money over into additional shares of firm stock or new investments. Conservative investors may choose to add blue chip stocks that issue dividends to their portfolio for a stable income stream that provides more reliable returns compared to the rise and fall of stock prices.
Firms can receive tax breaks if they invest business profits in depreciable assets, such as machinery or buildings. Depreciation allows businesses to deduct these investments over a set period of years as business expenses, reducing their overall tax burden. State governments and section 179 of the Internal Revenue Code (IRC) frequently allow for bonus depreciation. If firms retain their profits in order to distribute dividends to investors, they will pay a corporate tax rate between 15 and 35 percent, as of 2011.
Investors will pay either a zero or 15 percent capital gains tax rate on dividends received and stock sales at the federal level if they hold onto stock for at least a year, as of 2011. The Internal Revenue Service (IRS) does not consider price appreciation on equities as gains until investors sell their shares. If a company forgoes paying dividends and invests profits in a business, investors will receive significant tax savings through price appreciation of their equity holdings, because fewer taxable events will take place.