Scrip dividends are certificates paid to the shareholders of a company. These certificates are given to the shareholders instead of cash dividends.
The certificate allows the shareholders of the company to receive their dividends as either cash dividends or stock dividends.
This means when a scrip dividend is paid, the shareholders of the company decide whether they want to receive their dividends as cash or as shares of the company.
Scrip dividends can be beneficial for both the company and its shareholders. Companies generally use scrip dividend alternatives when their cash resources are low or they want to maintain a certain level of cash reserves.
This allows companies to invest the cash into other projects or processes while also providing shareholders with dividends.
For example, if the company expects to invest in a fixed asset in the next period, it may issue scrip dividends as a way to reserve cash to invest in the fixed asset.
For shareholders, scrip dividends allow them to increase their shareholding in the company. Through scrip dividends, they can acquire new shares of the company without having to pay further processing costs involved with acquiring new shares.
These processing costs may include commissions paid to brokers, stamp duties, etc. Shareholders can also sell their shares in the market, after receiving them, for capital gains.
Scrip dividends can also have some disadvantages for the company and the shareholders. For companies, scrip dividends can send a negative signal about the company in the stock market.
If a company uses scrip dividends often, potential investors may think that the company has cash flow problems and cannot pay dividends. This makes investing in these companies unattractive for potential investors.
Furthermore, scrip dividends can cause the market share prices of a company to be diluted. This will cause a decrease in the share prices of a company in the market which can also act as a negative signal.
For shareholders, scrip dividends can also potentially cause them to lose their percentage of ownership of a company.
If a shareholder opts to receive cash dividends but other shareholders of the company opt for the share dividend, then the shareholder will have the same number of shares as before while the number of shares of other shareholders will increase.
In most companies, cash dividends are more common than scrip dividends. Therefore, some shareholders may be confused about the tax treatment and implications of scrip dividends.
The process of taxation of scrip dividends starts from the financial institution, such as banks or brokerage firms, through which the shareholder receives their dividends.
Scrip Dividends On Tax Returns
Script dividends are reported using Form 1099-DIV. For shareholders, when they are preparing their tax returns, scrip dividends should be reported as income for the period.
However, if the shareholders choose to hold their shares in a retirement account, these are not taxed in the year they are earned.
The ‘Form 1099-DIV: Dividends and Distributions’ is sent to taxpaying individuals by financial institutions.
The financial institutions send the form to individuals with any dividend or distribution incomes from their investments within a calendar year that is above $10.
If an individual receives different dividend incomes through different institutions, they may also be sent multiple copies of Form 1099-DIV. The forms are reported in the taxpaying individual’s tax returns.
The financial institutions typically send these forms to the taxpayers before 31st January every year. Taxpayers are then required by the IRS to file the information on each Form 1099-DIV they receive on their tax returns.
The information is reported on a Schedule B form of the taxpayer or directly on their Form 1040. This is the normal process for ordinary dividends received by individuals but also applies to scrip dividends.
DRIP dividends can also be reported using the same process.
Scrip dividends are treated in the same manner as ordinary dividends paid in cash for tax purposes.
The dividend income that is received by individuals, whether in the form of cash or stock, is taxed at the same rate as other incomes of the individuals based on how much their total income is.
Conclusion
Scrip dividends are paid by a company when the company is short on cash resources. It is an alternative to cash dividends.
Scrip dividends have many advantages and disadvantages for both companies and their shareholders. Shareholders receive Form 1099-DIV for dividends from the financial institution through which they receive their dividends.
Shareholders can also receive multiple copies of these forms from different financial institutions. The information on the form is reported on the tax returns of the shareholder.
