Nontaxable Distributions

Some of the amounts reported to you on Form 1099-DIV are not taxable, because they are really a return of your original investment, or a return of capital, and not actually a dividend. If you received this type of distribution, it will generally be reported in Box 3. Once you have received all capital you paid in to the investment, any further amounts are taxable income.

While return of capital amounts will not appear on your tax return, you should keep a record of them, since they must be used to reduce your basis in the stock when you sell. Plus, any amount you receive after your basis is zero is taxed as capital gains.

Stock dividends and distributions. If a corporation of which you're a shareholder pays dividends in the form of shares of stock, or spins off a subsidiary and gives all shareholders of record some shares in the newly created company, the distribution is not taxable until you sell the shares at some point down the road.

An exception to this rule applies if you receive stock or stock options or rights when you or any other shareholder had the choice between receiving such rights or cash, or when different shareholders receive different types of stock or stock options. In that case, the stock or options would be taxable at their fair market value. For more information on this subject, see the IRS's free Publication 550, Investment Income and Expenses.

Liquidating distributions. If the corporation is being liquidated, you may receive payments shown in Boxes 8 or 9 of Form 1099-DIV. These are nontaxable distributions to the extent that they repay your basis in the investment. If you receive more than your basis, the excess is considered capital gains. If you ultimately receive less than your basis, you may have a deductible capital loss. See our discussion of investment gains and losses.

Dividends on an insurance policy. Occasionally, certain forms of insurance companies send "dividends" to their policy holders, generally in years when the company has taken in more premium payments than it needs for operating expenses, reserves, and benefit payouts. These dividends are treated as a rebate of premiums you paid and are not taxable as dividends on Schedule B. However, if the amount received exceeds the premiums paid, that amount is taxable.

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