Stock Dividends and Section 306 Stock under the US IRS TAX CODE - Case Study Example

Stock dividends and section 306 stock under the US IRS TAX Stock dividends and section 306 stock under the US IRS TAX This study explores the stock dividends and the role of the IRS in the taxation of dividends. Furthermore, the study looks at the stock dividend taxation under the section of 305 and 306. In addition, the study focuses on the various mitigation measures that have taken place in the taxation of dividends and tax laws, which have altered the decision on the latter. Moreover, the study will focus on the preferred stock bailout under section 306 of the investment act. Stocks dividend is simply an issue of securities by a company to all its shareholders or part of them. Distributed stock is classified together with shareholders holdings whereas a stock dividend is equivalent to a stock split. The difference is that a stock dividend requires the company to assign appropriate cash from reserves to be paid in capital. While a stock splits, it increases the number of outstanding shares without any adjustments to the corporate capital account. Companies pay little on common stock dividends instead of cash ostensibly to keep their shareholders with some tangible evidence of their investment in corporate earnings; at the same time, this allows the company to maintain resources for use in the business (Dickinson, 2008). Such distribution may have a minor impact on the price of the stock, bringing about a shareholder public relations gesture than an event of any financial consequence. Stock splits tend to increase the number of shares; thus, they reduce the price per share while trying to hike the market value of the stocks (Steven & Bank, 2010). Effort Preferred stock can be structured with dividends rights same as liquidation preference so that its value absorbs most of the net worth of the company, leaving the common stock with only its nominal value. This distribution of preference stock to the older is usually tax free, and since its value will be significantly reduced, the older may switch to younger through the value of gifts or sales of common stock. The tax consequence of the stock distribution to the older in section 305 remains significant in the current tax environment (Steven & Bank, 2010). Section 305 provides that gross income does not include an allocation of stocks by the company to its stock holders in relation to the companys stock. However, this condition is subject to various exemptions with an example found in section 305(b). These exemptions are essential as an inquiry in analyzing the tax consequences of stock distributions held (Chirelstein, 1997). Stock Rights and Stock Dividends—Sections 305 and 306 find the origin of tax treatment of stock distributions. It looks at the preferred stock and standards and policies set by the committee. Moreover, the portfolio criticizes the current treatment of stock distribution (Caron, 2003). This set discusses when an allocation will be rateable, what factors must be measured in shaping whether the stock viewed as preferred or common, when an allocation of preferred stock is subject to taint under section306, and the basis and investment period issues adjoining stock distributions. Stock Rights and Stock Dividends—Sections 305 and 306 have some notable benefits. First, research on the original tax planning methods is carried out by qualified practitioners; it has very useful practice papers as well as tables, charts and lists, and language guidance from various world experts. Moreover, it has an in-depth analysis that allows for exploration of various options, time-saving admittance to significant sections of regulations, court cases, tax laws, IRS documents among others, and other approaches to both common and different tax scenarios (Johnston, 2005). Stock dividend taxation under section 305and 306 The revenue act of 1916 provided that stock dividend be considered as income with the amount of its cash value. In the case Eiener v.Macomber, Mrs. Macomber, a common shareholder, received a proportionate distribution of additional common stock (Liam & Murphy, 2004). The court ruled that the distribution was not taxable because it did not constitute income, altering the meaning of the 16th amendment to the constitution. This provision in the case has led to a discredit on the ruling with the reshuffling in the corporation’s capital on common stock dividends evidencing the same interest held before distribution. The congress responded to the Supreme Court interpretation of the 16th amendments with a declaration that the stock will not be taxable (John, 2001). Another case involving Koshland v. Helvering brought a contradiction on the ruling made in Macombers Case. Koshland was a shareholder who owned accumulative nonvoting preferred stock (David, 2008). Koshland received a distribution of voting common stock. Koshland argued that she deserved to use the stocks full cost basis in determining her gain. Now, since the common distribution stock was received tax freely, the court contended that a proportionate amount of Mrs. Koshland basis in her preferred share should be allocated to the common stock, thereby increasing the gain on the disposition of her preferred stock. The court agreed with Mrs. Koshland’s assertions and ruled in her favour (Bruce & Ackerman, 2000). The ruling was based on the sixteenth amendments where a stock dividend gave a stockholder high interest, which varies from what the former stock had offered. This dividend is taxable as income under the sixteenth amendment. Whether congress had already taxed it, especially when it was received, remains immaterial for the present purposes. The enactment of the IRS code of 1954 changed the provision in the predecessor section 305, largely as an expression of dissatisfactions with the proportionate interest test. A more elaborate system was adopted in the tax reform of 1969. The following provision borrowed from the senate finance committee report on tax reform act of 1969 (Jentz, 2008). Under the present law in its simplest form, a stock dividend is commonly thought of as mere read adjustments of the stockholder’s interests and not as income. The present law provides that if a company pays a dividend to the shareholders in its own stock, then the shareholders should not comprise the value of the dividend to the income (Dickinson, 2008). This rule has two exceptions; first, the stock dividends paid when releasing preference dividends for the current year are taxable. Second, stock dividend is taxable if the shareholder chooses to receive his dividend in cash or assets instead of stock. After the enactment of the IRS, the ability of the stocks dividends is determined through the proportionate interest test. It was held that stock dividend is taxable if it increases any shareholders proportionate interest in the company (Lathrope, 2006). Following the abolishment of the proportionate interest test, corporations adopted new methods by which shareholders could be given a choice on whether to be receiving cash dividends or an increment in their interest of the company. This would happen in the same manner they had acquired the dividends and reinvested them in the same company. One of the Methods involved the introduction of two groups; A and B. These groups are to share the profits and earnings equally and in assets on liquidation. Class A stocks pay stock dividends only while class B pays only cash dividends (Chirelstein, 1997). The value of the stock paid by class A stock is annually to the cash dividends of class B. Class A may be converted to class B anytime at the choice of the shareholder. The shareholder can also determine when the class should be established; whether after the purchase of a new stock or through convertibility option from class A to class B (Bruce & Ackerman, 2000). With this proposal, the policy in present law did not cover all the engagements by which cash dividends are paid to a number of shareholders. As a result, other shareholders can be given the same increases in proportionate interest (Johnston, 2005). General reasons for changes devised other methods to give preferred stockholders the equivalent of dividends, which are not taxable under present law. Dividends paid on stock should be taxed, whether they are received by cash, or in other forms such as stocks or the rights to receive them, or an increase on the redemption received. The committee anticipated that the tax should be charged on the person receiving the dividends, whether endorsed to the current or instantly former taxable year or the earlier taxable years (Caron, 2003). Section 305 of the bill has a provision that a stock dividend can only be taxed if payable at the choice of any shareholder in assets instead of stock. Section (b) (2) provides that if there is an allocation of stocks, which has the result of the delivery of assets, stocks, and other property by a number of shareholders and an increase in the balanced interests, especially in other shareholders, the assets or earnings, and the profits of the company, and the shareholders receiving the stocks are to be taxed (Liam & Murphy, 2004). The finance committee has added two other provisions to the house bill section 304 and 305. They carry the purpose of the house with a view to distribute common and preferred stock on common stock, and stock distributions on preferred stock. The second provisions provided that distributions of stock with respect to preferred stock should be taxable. These provisions apply to all the allocations on the preferred stock, with the exception of an increase in the conversion rate of the convertible preferred stock, which may be made solely to recognized account of stock dividends, or a split in stock when relating it to the convertible stock (John, 2001). Preferred stock bailout under section 306 Section 306 is among a number of anti-bailout provisions, which tend to be of less significance in situations where dividends and long-term capital gains from taxpayers outside the corporate world are subjected to taxation at similar preferential rates (Cross, 2008). Section 306 was specifically designed to target preferred stock bailout, which refers to a device traditionally used by shareholders to obtain corporate earnings at extremely fair capital gains rates. An example of a situation where preferred stock bailout was highly applicable involved transactions where a profitable corporation would distribute preferred stock to its common shareholders on a tax-free basis (Frank & Cross, 2008). The common investors would then sell the preferred stock to accommodating investors such as insurance companies. After a prolonged period, common shareholders would report capital gain on their investment. The corporations would later, after several years, redeem the preferred stock from the investors. Common shareholders benefited through such operations by receiving cash without losing any fraction of their proportionate interest in their respective corporations (Bruce & Ackerman, 2000). Drafters of the 1954 code were faced with a serious dilemma on whether to make changes on the bailout by introducing taxation on all preferred, common stock dividends, or to avoid taxation until the shareholder disposed off stock with bailout potential. Common shareholders who benefit from proportionate preferred stock have not gained interest in their respective corporations. The shareholders have a tax opportunity, but they have an option to forego it due to non-tax reasons. This fact, together with other non-tax objectives, forced the congress to rebel stock with bailout potential as section 306 stocks. Therefore, this move demanded that shareholders should report ordinary income instead of capital gain after selling or redeeming section 306 stocks (Chirelstein, 1997). Nowadays, dividends and long term capital gains are taxed uniformly at a low rate. The numerous benefits previously gained from bailouts awarded in corporations at capital gains rates have reduced significantly. However, non corporate shareholders of sale have two tax advantages; in special occasions, they have the ability to offset capital gains and ability to recover stock. Section 306 is still a component of the code, although it awaits the congress to draw a clear line between dividends and capital gain (Lathrope, 2006). Conclusion A stock dividend refers to the amount of capital that shareholders earn from their investments. At times, the shareholders are at liberty to use the cash received or to reinvest it back into the Corporation. The dividend paid to the shareholder can help the company to attract many people who will be willing to invest in such a company. The ISR regulates the amount of dividends to be paid to the shareholders. The ISR is also mandated to carry out research on the planning methods to determine the tax laws by qualified practitioners, as well as to establish the violation of the laws. The sixteenth amendment to the constitution provided that the dividends should not be taxed since they cannot be regarded as part of the income. In 1969, a tax reform was conducted; it changed the previously used provision on dividends. 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Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich-- and Cheat Everybody Else. New York: Portfolio. Lathrope, D. J. (2006). Selected Federal Taxation Statutes & Regulations, with Motro Tax Map 2007. New York: West Group. Liam, B. & Murphy, T. N. (2004). The Myth of Ownership:. London: Oxford University Press. Steven, A. & Bank, K. J. (2010). Selected Sections: Federal Income Tax Code and Regulations, 2010-2011. New york: West Group. Read More