Tax Answer

LESSON 5

DIVIDENDS and OTHER NONLIQUIDATING DISTRIBUTIONS

5A General

GENERAL COMMENTS: Particularly if Lesson 4 on debt/equity has been skipped at this point, consider discussing generally the nondeductibility of dividends as compared with interest and the influence of that fact on LBOs and corporate behavior generally. See Lesson 4. Consider also contrasting the state law definition of dividends. Discuss the actual role of dividends in corporations today, vis-à-vis other methods of moving corporate income to equity owners (e.g., AT&T must pay dividends, but Mom & Pop, Inc., has other options; more to come on stock repurchase plans in lesson on redemptions). But 2003 legislation reducing the top tax rate on dividends to 15 percent (the same as capital gains) has significantly changed the tax stakes in this Lesson (tilting the scales far more favorably to dividend treatment than former law).

(1) Let’s set out the basic operation of § 301 first. A realizes an amount distributed of $200, of which A recognizes $50 as a dividend. IRC §§ 301(a), 301(b)(1), 301(c)(1), and 316(a). The remaining $150 of the distribution reduces A’s stock basis by $100 to zero and A recognizes the final $50 of the distribution as capital gain. IRC §§ 301(c)(2), 301(c)(3). The alternative produces the same result. Regs. § 1.301-1(m). Both the dividend and the capital gain are taxed at a top rate of 15 percent.