The Internal Revenue Service collects taxes on personal taxable income. The IRS considers all income which is not specifically exempted from taxation to be taxable income. This includes both earned income -- such as salaries, wages, commissions, bonuses and tips -- and unearned income, such as interest, dividends and capital gains. Dividends and capital gains are examples of income produced by investments.
Corporations may distribute property, which may be in the form of money, stock or other some other valuable consideration, on a pro rata basis to the corporation's stockholders. These distributions are called dividends. The most common type of dividend is the ordinary dividend. Ordinary dividends represent a share of the corporation's profits and earnings and are typically paid in cash. Ordinary dividends are usually subject to taxation as ordinary income.
A capital gain represents the realized increase in the value of an asset. You may have a capital gain on any investment or security that you purchase at one price and later sell for a higher price. The difference in the purchase price and the sale price is your capital gain. Capital gains are divided into two types: short-term capital gains and long-term capital gains. You do not have a capital gain until you sell the underlying asset.
Short-Term vs. Long-Term
A short-term capital gain results when you sell an asset for more than you paid for it and you have owned the asset for one year or less. A long-term capital gain results when you sell an asset for more than you paid for it and you have owned the asset for more than one year. Long-term capital gains are taxed at a more favorable rate than short-term capital gains. For most individual taxpayers, the maximum long-term capital gains rate for the 2010 tax year was 15 percent.
All corporations that pay you more than $10 in dividends should provide you with a Form 1099-DIV which identifies all taxable dividends you were paid. Certain organizations, such as partnerships, trusts and estates, may also pay dividends, but they would report your taxable amounts on Schedule K-1. You must report all taxable dividends when you file your federal income tax return. You must also report your capital gains when you file your federal income tax return. You report your capital gains on Schedule D, and include the total amount on Line 13 of IRS Form 1040, as of the 2010 tax year.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.