7934 / What is a capital gain dividend? How is a RIC shareholder taxed upon distribution of a capital gain dividend?

A RIC capital gain dividend is a dividend that the RIC designates as a capital gain dividend in a written notice to its shareholders.¹ If the RIC designates capital gain dividends that exceed the net capital gain of the RIC for the year, the capital gain dividend is the excess of (1) the reported capital gain dividend amount over (2) the excess reported amount that is allocable to the reported capital gain dividend amount.² Generally, if a RIC reports capital gain dividends that exceed its net capital gain for the year, the designation is ineffective.³

When the RIC designates the dividend as a capital gain dividend, it must also identify the tax rate that would apply to the RIC capital gain. This means that the RIC must designate the dividend as one of the following types of distribution:

(1)  a long-term capital gain distribution (taxed at the 20/15/0 percent rates that generally apply to long-term capital gains, see Q 704);

(2)  an unrecaptured Section 1250 gain distribution (taxed at 25 percent, see Q 702);

(3)  a 28 percent rate gain distribution (see Q 702); or

(4)  a Section 1202 gain distribution (dealing with gain that represents amounts from sale or exchange of qualified small business stock held for more than five years; a portion of this stock may be excluded from income (see Q 702, Q 7522)).

The RIC shareholder is taxed on the capital gain dividend according to the type of gain distribution that is identified by the RIC.⁴

Note that a RIC shareholder is generally taxed as though a RIC capital gain dividend is long-term capital gain, regardless of whether or not the shareholder’s holding period was more than one year.⁵

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1.  IRC § 852(b)(3)(C).