Constructive Dividend

[JohnH]

I seem to recall a discussion about this before, but I couldn't find it in a search. Pardon the repetition if my search skills are inadequate.

A sole shareholder of a profitable C-corp pays some personal expenses from the corp in the amount of about $8K. He also receives salary payments of about $38K from the corp reported on a W-2, but does not account for the $8K in personal expenses. Unless the payments are treated as a loan, then it seems to me these become Constructive Dividends and should be reported on Schedule B, even though a 1099-Div was not issued.

The question is, can the Contstructive Dividends be reported as Qualifying Dividends? Seems to me they can since the taxpayer meets the holding period, but I'd like to know if anyone has a different opinion.

[Snaggletoof]

Constructive

I would have to agree these are constructive dividends, but under the furthest stretch of imagination can not believe these are "qualifying" dividends. At least not in the manner Congress believed when they created them.

If this guy wanted the money so bad, all he had to do was declare a dividend of $8K and back it up with a corporate resolution. Then, assuming no negative factors, he would have had 15% taxation.

[JohnH]

So what disqualifies them?

Thanks for the input.
I don't have any interest in punishing the client for his sloppy way of handling things and I'm not in the business of doing IRS's job for them. I'm trying to do what's best for the client under the rules as they exist, whatever they may be.

The dividend payments do meet the basic definition of qualifying dividends and I don't know what Congress had in mind when they made the rule. Seems to me they would have written the law in such a way as to disqualify this type of payment if that was their intent. (They certainly knew what a constructive dividend was at the time the law was written).

But maybe there's some administrative guidance that I'm not aware of which would settle thie one way or the other. That's the gist of my question.

[Bees Knees]

The only real rule here you have to worry about is the holding period rule. If that is met, a constructive dividend does in fact meet the qualified dividend test.

The only thing Congress had on its mind was to reduce the double tax on dividends, but not allow that treatment to day traders who buy and sell stock on a daily basis.

[DaveO]

I agree with Bees

We have treated these as qualified dividends for our 'C" corps.

[JohnH]

Thanks All

Thank you Snags, Bees, & Dave.

That's what I like about this forum.
We can share our opinions AND our experience, plus get things done in the process.

[Golden Rocket]

Qualified? I guess so...

The only real rule here you have to worry about is the holding period rule. If that is met, a constructive dividend does in fact meet the qualified dividend test.

Interesting response, BK. Does constructive "receipt" by a shareholder result in a constructive dividend "paid" by the corporation? According to TTB 18-12, an auditor would make the adjustment for both the taxpayer and the corporation. But the fallout creates a disconnect in the corporation's treasury record. Dividends paid but not declared. Unequal distribution of dividends of profit among shareholders. Misstated per share information for the public auditor.

I think I'm fighting ghosts other than taxes. For tax purposes, I accept that you are right, and IRS doesn't really care about the carnage created in other areas. Another reason not to create a situation resulting in a constructive dividend. GR

[JohnH]

Not necessarily a big deal

No that I'd recommend this approach, but a constructive dividend in a small corp isn't really such a big deal, especially for a corp owned by a single individual. We huff & puff about "double taxation" , but in reality it's much less problematic in many cases than it first appears.

The corp tax rate of 15% is roughly the same as the total FICA/MED tax which would be paid on the payment if it were handled as compensation. If it is acceptable to then treat it as a qualified dividend, the income tax is actually a little lower than it would be on earned income. The taxpayer loses some SocSec earnings credits, but in terms of net tax paid it's probably a wash or maybe even a little lower.

[outwest]

Remember that tax and accounting are parrallel universes.

But the fallout creates a disconnect in the corporation's treasury record. Dividends paid but not declared. Unequal distribution of dividends of profit among shareholders. Misstated per share information for the public auditor.
GR

Just because the tax code has a certain tax treatment does not mean that accounting records have to match. The tax treatment is to assess taxes not to do accounting.

That said, the accounting profession recognizes taxes affect the economics of a firm and try to assess the overall impact with calculations of taxes paid, permanent and temporary differences, the new fin 48 standard, etc. But a constructive dividend for tax purposes on the tax side does not necessarily mean anything for accounting.

[Bees Knees]

Interesting response, BK. Does constructive "receipt" by a shareholder result in a constructive dividend "paid" by the corporation? According to TTB 18-12, an auditor would make the adjustment for both the taxpayer and the corporation.

Technically, you are correct. A constructive dividend is only a constructive dividend after the auditor has re-classified a particular transaction as a dividend. If that is the case, the shareholder will not have already treated it as a qualified dividend on the 1040 because the original tax treatment was to NOT treat it as any kind of taxable dividend.

However, in the original post, it appears it is the accountant who has discovered the typical corporate shareholder paying personal expenses during the year using the corporate checkbook. Even though no 1099-DIV was issued, and the corporation did not officially declare a dividend, the accountant believes this should be treated as a dividend, and decides to put it on the 1040 anyway. Having done that, is it a qualified dividend?

In this case, the term "constructive dividend" is used to describe a transaction that is reclassified as a dividend by the tax preparer so that the original returns are prepared correctly. It is a more generic use of the term.

However, even if we use the term properly and say an auditor has reclassified a transaction as a constructive dividend. Can the shareholder then use the 5% / 15% rate on the 1040 and say it is a qualified dividend?

Again, I don't know why not. I doubt the auditor would do this. But I think you could make a good argument for it if the auditor is going to insist on treating it as a constructive dividend.