Question

Which of the following statements regarding common stock dividends is true?

Group of answer choices

They provide a tax deduction for the corporation paying them, and they are not included in the taxable income of the recipients                                                        

They provide a tax deduction for the corporation paying them, but the recipients of the income must pay taxes on the income

They are paid out of the after-tax income of the corporation paying them, and the recipients also pay taxes on this income              

They are paid out of the after-tax income of the corporation paying them, so the recipients do not have to pay taxes on the income

Answer 1

Correct option:- They are paid out of the after-tax income of the corporation paying them, and the recipients also pay taxes on this income.

Justification:- Dividends can be defined as that part of profit of a company which is paid out to the owners of the company (shareholders) as a return on their investment which they have made by subscribing the shares of the company.
Dividends are not a charge against the company’s profit but they are an appropriation of company’s profits and it is generally a discretion of the company whether it wants to declare and pay dividends in any financial year( except for cumulative preference dividends).

Since dividend is an appropriation of profit it must be paid from after tax income of the company and as far as shareholders are concerned dividend is a return on their investment and is therefore taxable in the hands of shareholders also.