Page 478 - TaxAdviser_2022

CASE STUDY

Paying dividends as a

tax planning strategy

Editor: Qualified dividends are distributions of Paying compensation instead
Trenda B. Hackett, CPA cash or property made by a domestic or of dividends
qualified foreign corporation out of its For most closely held C corporations,
earnings and profits (E&P) to a avoiding the double taxation of cor-
shareholder with respect to its stock porate earnings has been the primary
(Sec. 1(h)(11)(B)). To qualify for the tax planning goal for many years. The
reduced rate on dividends, a shareholder traditional approach to the problem is
must hold the stock for more than 60 for the corporation to zero out its annual
days during the 121-day period begin- taxable income (or nearly so) by making
ning 60 days before the ex-dividend deductible year-end bonus payments
date. For preferred stock dividends at- to shareholder-employees. Legitimate
Determining the best tributable to a period or periods corporate payments for shareholder-
way to extract cash aggregating more than 366 days (e.g., employee compensation can be deducted
from a corporation cumulative preferred stock with divi- as ordinary and necessary business
dends in arrears), the holding period is
expenses (Sec. 162(a)(1)). Of course,
depends on more than 90 days during the 181-day shareholder-employee compensation
many factors and period beginning 90 days before the payments (including year-end bonus
amounts) are subject to Social Security
stock’s ex-dividend date. The holding
assumptions; here period includes the date of disposition tax and Medicare tax (Federal Insurance
is how to evaluate but not the date of acquisition Contributions Act tax). An additional
paying compensation (Sec. 246(c)(3)(A)). 0.9% Medicare tax applies to wages
To receive any dividend, the taxpayer
above a certain amount ($250,000 for
vs. dividends. must own the stock at least one day be- married filing jointly, $200,000 for single
fore the ex-dividend date. Because filers, and $125,000 for married filing
the required holding period is more than separately).
60 days during a period beginning 60 For tax years 2018–2025, an indi-
days before the ex-dividend date, this vidual’s taxable income is subject to
necessarily means that the holding seven tax brackets: 10%, 12%, 22%, 24%,
period must include the ex-dividend 32%, 35%, and 37%. Furthermore, an
date. However, the 61-day (or 91-day) additional tax applies to higher-income
holding period does not have to be individuals, depending on whether
consecutive. Also, certain transactions the payment is characterized as com-
that limit the taxpayer’s risk of loss (e.g., pensation or qualified dividends. The PHOTO BY COMSTOCK/STOCKBYTE/THINKSTOCK
This case study has been adapted from short sales and options to sell substan- additional 0.9% Medicare tax applies
Checkpoint Tax Planning and Advisory tially identical stock or securities) to compensation above a certain amount
Guide’s closely held C corporations
topic. Published by Thomson Reuters, suspend the taxpayer’s holding period ($250,000 for married filing jointly,
Carrollton, Texas, 2022 (800-431-9025; until those transactions are closed $200,000 for single filers, and $125,000
tax.thomsonreuters.com). (Sec. 246(c)(4)). for married filing separately). The 3.8%

38 September 2022 The Tax Adviser