Constructive Dividends
Constructive Dividends
In Ltr. Rul 20028806, the shareholders of a corporation owned, managed, and operated country club were given discounts for the use of the club’s facilities. The club was located in a community where both non shareholders and shareholders resided. Shareholders received discounts on membership dues as well as other incentives inside the club. Taxpayer requested a letter ruling on whether or not the discounts received constitute as constructive dividends received. The IRS indeed ruled the discounts received by the taxpayer constituted as constructive dividends under section 316 and the distribution applied to section 301. A constructive dividend is a form of payment made by a corporation to its shareholders that resulted in any measurable economic benefits to the shareholder. It can either be a direct or an indirect form of payment and mostly occurs in closely held corporations. These payments can also be distributed both advertently and inadvertently. Some of the most common types of constructive dividends revolve around personal use of corporation’s property, personal expenses of shareholder paid by corporation, unreasonable rental payments, unreasonable compensations, and other types of shareholder withdrawals. Their main purpose is to avoid reporting dividend income. In later paragraphs, we will discuss various cases where corporations purposely avoid reporting dividend income. Why do corporations distribute constructive dividends? What are the motives behind distributing other form of payments to shareholders other than distributing regular dividends? “Tax savings” is the answer to the above questions. Dividends are subject to “double taxation” where the distributions are taxed at both the corporate and individual taxpayer (shareholder) level. By distributing payments in other forms, the taxpayers and corporations are able to avoid the double taxation effect. They are able to distribute compensation and rental payments that can be
In Ltr. Rul 20028806, the shareholders of a corporation owned, managed, and operated country club were given discounts for the use of the club’s facilities. The club was located in a community where both non shareholders and shareholders resided. Shareholders received discounts on membership dues as well as other incentives inside the club. Taxpayer requested a letter ruling on whether or not the discounts received constitute as constructive dividends received. The IRS indeed ruled the discounts received by the taxpayer constituted as constructive dividends under section 316 and the distribution applied to section 301. A constructive dividend is a form of payment made by a corporation to its shareholders that resulted in any measurable economic benefits to the shareholder. It can either be a direct or an indirect form of payment and mostly occurs in closely held corporations. These payments can also be distributed both advertently and inadvertently. Some of the most common types of constructive dividends revolve around personal use of corporation’s property, personal expenses of shareholder paid by corporation, unreasonable rental payments, unreasonable compensations, and other types of shareholder withdrawals. Their main purpose is to avoid reporting dividend income. In later paragraphs, we will discuss various cases where corporations purposely avoid reporting dividend income. Why do corporations distribute constructive dividends? What are the motives behind distributing other form of payments to shareholders other than distributing regular dividends? “Tax savings” is the answer to the above questions. Dividends are subject to “double taxation” where the distributions are taxed at both the corporate and individual taxpayer (shareholder) level. By distributing payments in other forms, the taxpayers and corporations are able to avoid the double taxation effect. They are able to distribute compensation and rental payments that can be