Are Dividends an Expense?

The very short answer is NO. Let's dig a little deeper into the old textbooks to explain why, and what some of the common mistakes are.

Definition of Dividends

A dividend is the return of profits to shareholders.  They show up on a balance sheet and in traditional GAAP accounting in the Statement of Cash Flows.  For small business owners, dividends show up if the business is organized as a corporation, an S-Corp or C-Corp.

Sometimes dividends are confused with distributions.  Distributions are very similar but apply to businesses organized as a partnership.  Distributions also don't have to be from business profits.

Purpose of Dividends

Essentially dividends are a return of capital to the shareholders.  This is essential for shareholders to receive a return on their invested capital.  If the company never paid dividends the owners of the corporation would never share in the profits.

For small businesses, dividends are a critical tax strategy tool.  Many S-corporations pay dividends to the owners to supplement their W-2 income for their personal income.  In other cases, S-corporations pay dividends to allow the shareholders to pay personal income taxes from the S-Corp.

Types of Dividends

Dividends can take multiple forms.  Their is the traditional cash dividend, but dividends can also be paid out in the form of stock or company property.

Cash Dividend Payments

The most common type of dividend payment is cash.  The board of directors determines the amount of profits to be paid out to the shareholders (owners).  Then each shareholder is paid based upon their percentage of outstanding shares.

For example, if you have a company with 2 shareholders, and one owns 60% of the company, while the other owns 40%.  Let's assume they decided to pay $100k in dividends.  The first shareholder would receive a dividend of $60k and the second would receive $40k.

Stock Dividend Payments

Stock dividends are rarely used for small businesses.  For larger businesses, stock dividends are used to conserve the company's cash position, but still give the shareholders a return on their investment.  The same method is used as cash dividends, but instead of a check, shareholders receive additional stock in the company.

For publicly traded companies the amount of stock issued is based upon the current market price.  For other businesses, a valuation of the company stock has to be determined. 

Property Dividend Payments

Property dividends are rarely used  in normal situations.  Property of the corporation can be distributed in lieu of cash, usually done when the company doesn't have any cash.  Property dividends are commonly used in the discontinuation of a business.

The largest problem with property dividends is determining the value of the property to be distributed.

Accounting for Dividends

I know all of you are eager to learn how to account for dividends.  I'll save you the trouble of reading an accounting text.  Here are the basics.

Common Stock V. Preferred Stock

Public companies often have complex capital structures.  Preferred stock as the name implies has preference over common stock.  They receive returns of profit first, and if there is any remaining, then the company pays the common shareholders.

Accounting

Once a dividend has been determined and the form of dividends decided based upon the shares outstanding, the company records a dividend payable.  This shows up on the balance sheet in other current liabilities.  The offset to this is the company earnings.

The dividends payable will be based upon owners of the shares as of a specific date.  Once the dividend distribution has been made, the dividend payable is removed.  This process is done for both common shares and preferred shares.

Where to Find Dividends in a Financial Statement

If you look at a company's balance sheet, there is usually no detail on retained earnings, just one line item in the Owner's Equity Section, after assets and liabilities. For companies whose financial statements contain footnotes, there is a Statement of Retained Earnings that shows the beginning balance of the retained earnings account, the increase (or loss) from the current year, current year dividends, and any other adjustments.

You can also find dividends listed in the Statement of Cash Flows. Most companies don't regularly produce this financial statement, but it is a requirement to have financial statements comply with Generally Accepted Accounting Principles (GAAP). Dividends will show in the Activities From Financing Section.

Operating Expenses Vs. Dividends

Operating expenses are those those costs your business has while attempting make a profit. Your rent, your employees, supplies, and insurance. The IRS has a standard of "reasonable and necessary" to make a profit. Obviously very broad term. This is opposed to a dividend, which is when the profit distributes those profits.

Dividends don't show up on the income statement as an expense. Rather they are reflected on the Balance Sheet as a return of capital.

How Do S-Corporation Owners Get Paid?

Where trouble comes for most small business owners if then the regularly pay themselves both a salary and Cash Dividends. The first problem is that they don't pay themselves a reasonable salary. You can read more in this article on the subject.

The second issue is that they code their dividends as an expense. Usually this is a line item like Payroll, Owner's Compensation, or Wages. This counts the dividend as an expense, and if the tax preparer is not diligent, they will tax those dividends as an incorrect expense. Ticking bomb for the IRS auditor.

A third problem that shows up is when there are more than one owners. Dividends have to paid proportionally, which means if there are two partners that one 50%, they have have to receive the same dividend amount during the year.

Lastly, if there are no retained earnings in the business for tax purposes, then you can't have dividends. Distributions out of an S-corp where there are no retained earnings are subject to capital gains tax.

Conclusion

In conclusion, while dividends may not be considered an expense in the traditional accounting sense, they certainly have a significant impact on a company's financial health and investor relations. Whether you're a shareholder or a business owner, understanding the implications of dividends is crucial for making informed decisions. So, next time you receive a dividend payout or consider implementing a dividend policy, remember to weigh the benefits and potential drawbacks.

 

Discover if dividends are considered an expense and how they impact a company's financials. Dive into the details with this informative article.