Tax changes

Quote: AZDuffman

Well, if there is no income to tax then no tax should be due. It does not matter because again, it is nothing more than a sole proprietorship crediting a drawing account and debiting cash because the owner is taking some money out.

Income or loss, it does not matter as any tax liability is paid at the corporate level. The dividend is just letting the owners take a draw.

There is income to tax; the personal income from the dividend.

Think of it this way: If you were a sole proprietorship and took money from the business, then you would be taxed (or not) all the same because the business is not itself taxed separately. When it comes to Common Shareholders, each share of stock you own represents some (usually infinitesimal) percentage of the company you own, at least, relative to other Common Shareholders. As we've seen with so many corporate Chapter 7's, in terms of real value, shareholders effectively own nothing sometimes. At least, they own nothing if the company liquidates and what it liquidates for can't make it to common shareholders without every other category of shareholder, and creditors, getting paid first.*

*Obviously, that's generally the case (or very close to) or the corporation wouldn't be filing a Chapter 7.

However, you have your shares of stock, which are a negotiable instrument that has not reached a final disposition. Granted, you have likely gained or lost paper value on it, but until such time that you sell it, you haven't done anything.

Dividend payments are an exception to that. While the shareholders equity in the business is reduced as a result of a company paying dividends, the fact remains that your holdings in the company (as a percentage of ownership) are unchanged relative to other shareholders.

In other words, you saw a return on your investment, which is income.

There are probably all sorts of theoretical ways that you can offset that income with a deduction, but the fact remains that it's income. You are partially an owner of that corporation and that corporation decided to pay the owners a dividend; however, the percentage stake that the owners have in the company has not been reduced and is unchanged.

You might argue that the absolute value of your investment (which, per the above Chapter 7 bankruptcies, has often been proven to be nothing, anyway) has been decreased because of the company reducing its cash on hand, and therefore, its own assets such that the dividend has caused you to own the same percentage of a smaller asset pool, but then, there was no force external to the company that forced it to pay a dividend in the first place.

Either way, the company made a payment to you. Because the company made a payment to you, it becomes personal income and can be taxed as dividend income accordingly. There's a form for it and everything!

Think of the extreme case if you were ideologically correct on this one; the extreme case would be that a company could liquidate itself to the greatest extent possible (without filing Chapter 7) and then announce a HUGE dividend to be paid out to shareholders. If a company knew it was going under either way, it might as well just say, "Screw the creditors," and pay out everything it can convert to cash to its shareholders AND THEN file a Chapter 7. It would be made even better by the fact that the shareholders wouldn't have to pay personal income tax on it, if things happened according to your view.

Quote: Mission146

There is income to tax; the personal income from the dividend.

Think of it this way: If you were a sole proprietorship and took money from the business, then you would be taxed (or not) all the same because the business is not itself taxed separately. When it comes to Common Shareholders, each share of stock you own represents some (usually infinitesimal) percentage of the company you own, at least, relative to other Common Shareholders. As we've seen with so many corporate Chapter 7's, in terms of real value, shareholders effectively own nothing sometimes. At least, they own nothing if the company liquidates and what it liquidates for can't make it to common shareholders without every other category of shareholder, and creditors, getting paid first.*

*Obviously, that's generally the case (or very close to) or the corporation wouldn't be filing a Chapter 7.

It does not matter if the tax is separate or not, the tax has been paid.

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However, you have your shares of stock, which are a negotiable instrument that has not reached a final disposition. Granted, you have likely gained or lost paper value on it, but until such time that you sell it, you haven't done anything.

Dividend payments are an exception to that. While the shareholders equity in the business is reduced as a result of a company paying dividends, the fact remains that your holdings in the company (as a percentage of ownership) are unchanged relative to other shareholders.

In other words, you saw a return on your investment, which is income.

Said income was already taxed, at the corporate level. As you said, I am part of that corporation along with every other shareholder.

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There are probably all sorts of theoretical ways that you can offset that income with a deduction, but the fact remains that it's income. You are partially an owner of that corporation and that corporation decided to pay the owners a dividend; however, the percentage stake that the owners have in the company has not been reduced and is unchanged.

None of this matters as it relates to dividends. The income was taxed, the tax was paid. Any capital gain I make selling my shares is a separate issue, though my personal belief is that should be tax free since both the income has been taxed or will later be taxed and lots of it is taxing me on inflation which is its own hidden tax.

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Think of the extreme case if you were ideologically correct on this one; the extreme case would be that a company could liquidate itself to the greatest extent possible (without filing Chapter 7) and then announce a HUGE dividend to be paid out to shareholders. If a company knew it was going under either way, it might as well just say, "Screw the creditors," and pay out everything it can convert to cash to its shareholders AND THEN file a Chapter 7. It would be made even better by the fact that the shareholders wouldn't have to pay personal income tax on it, if things happened according to your view.

The only case I can think of close to this is pets.com. They saw they were dead in the water so decided to liquidate before they were broke. After it was all settled the shareholders got something. What you describe is called a "bust out" and the mafia does it regularly. If you try and get caught you will probably end up in Allenwood or a similar facility.

But your idea is not going to work well larger scale. Most credit is secured by something, meaning liens will have to be paid before cash was received out of any escrow. Some suppliers will get wind fast and shut off supply.

None of this changes the fact that the tax on the income of the dividend was paid at the corporate level. It is called "double taxation" for a reason.

You 2 are certainly making a simple thing complicated. Dividends are always paid out of profits, not necessarily profits from the companies same fiscal period. The companies profits that are not paid out immediately go to retained earnings. Dividends reduce the retained earnings.

In Canada you pay some taxes on dividends. The amount that you receive is run through a formulae that reduces the amount you claim to allow for the taxes that the company has already paid on the dividend you received.

Quote: kenarman

You 2 are certainly making a simple thing complicated. Dividends are always paid out of profits, not necessarily profits from the companies same fiscal period. The companies profits that are not paid out immediately go to retained earnings. Dividends reduce the retained earnings.

In Canada you pay some taxes on dividends. The amount that you receive is run through a formulae that reduces the amount you claim to allow for the taxes that the company has already paid on the dividend you received.

Again, no. In theory, a company could never have had profits and still choose to pay a dividend to shareholders. Do you guys all think that major corporations spawn into existence, like a business simulator game, and just magically have a few billion in their account?

I'm not making anything complicated. Dividends result in a debit to cash and a reduction to shareholders' equity; that's it. The dividend transaction is independent of anything else to the extent that it's a wholly internal transaction.

Granted, it sometimes doesn't come from shareholders' equity directly. On occasion, a company will create a liability and call it, "Dividends payable," At that point, you would debit retained earnings/shareholders' equity and credit dividends payable to create the liability.

It still doesn't matter though simply because that's not how income tax works. Income tax cares about taxable periods of time, which for individuals, is every year. You made an investment of x amount of shares of stocks, you still own whatever x was and you got paid a dividend. Therefore, it is RoI, and therefore, income.

One relatively easy way to not pay taxes on that income (if such is the goal) is to use a deduction you can get for interest paid on investment capital...or some verbiage like that. I forget exactly what the deduction is called, but suppose you borrow money for the purpose of investing (on the presumption, one would assume, that you can invest such as to beat the interest that you pay); okay, so you borrow money for investing and invest that money (in order to take the deduction, you MUST invest the money), if you were paid a dividend and that became income, you could itemize your tax return and take the deduction for interest paid on investment borrowing.

Essentially, that would partly (or wholly) nullify the dividend, for tax purposes. Obviously, the deduction you take for that cannot exceed the amount that the dividend(s) paid out, so it's kind of like the W-2 G offset, in that regard.

If you structure this correctly and strongly believe that the company will continue its dividend payouts, then you can borrow the money for the purposes of investing, invest in a dividend yielding stock and use the dividend to cover the interest on the loan. In effect, you borrowed money to purchase shares of that stock, interest free, assuming everything works out.

Not interest free, exactly; you're still paying the interest (and principle) back over time, but the amount of the dividend payouts covers the interest and you don't end up paying taxes on those dividends. Essentially, that creates an interest free loan, in effect.

It also doesn't have to be that specific stock; you just have to use the money for investing. Thus, if you already own a stock that pays out dividends, then you can borrow some amount to invest it in other things such that the interest you would pay on that loan for investment capital is covered by the dividend.

Sheesh!

Quote: Mission146

Again, no. In theory, a company could never have had profits and still choose to pay a dividend to shareholders. Do you guys all think that major corporations spawn into existence, like a business simulator game, and just magically have a few billion in their account?

I'm not making anything complicated. Dividends result in a debit to cash and a reduction to shareholders' equity; that's it. The dividend transaction is independent of anything else to the extent that it's a wholly internal transaction.

Granted, it sometimes doesn't come from shareholders' equity directly. On occasion, a company will create a liability and call it, "Dividends payable," At that point, you would debit retained earnings/shareholders' equity and credit dividends payable to create the liability.

It still doesn't matter though simply because that's not how income tax works. Income tax cares about taxable periods of time, which for individuals, is every year. You made an investment of x amount of shares of stocks, you still own whatever x was and you got paid a dividend. Therefore, it is RoI, and therefore, income.

One relatively easy way to not pay taxes on that income (if such is the goal) is to use a deduction you can get for interest paid on investment capital...or some verbiage like that. I forget exactly what the deduction is called, but suppose you borrow money for the purpose of investing (on the presumption, one would assume, that you can invest such as to beat the interest that you pay); okay, so you borrow money for investing and invest that money (in order to take the deduction, you MUST invest the money), if you were paid a dividend and that became income, you could itemize your tax return and take the deduction for interest paid on investment borrowing.

Essentially, that would partly (or wholly) nullify the dividend, for tax purposes. Obviously, the deduction you take for that cannot exceed the amount that the dividend(s) paid out, so it's kind of like the W-2 G offset, in that regard.

If you structure this correctly and strongly believe that the company will continue its dividend payouts, then you can borrow the money for the purposes of investing, invest in a dividend yielding stock and use the dividend to cover the interest on the loan. In effect, you borrowed money to purchase shares of that stock, interest free, assuming everything works out.

Not interest free, exactly; you're still paying the interest (and principle) back over time, but the amount of the dividend payouts covers the interest and you don't end up paying taxes on those dividends. Essentially, that creates an interest free loan, in effect.

It also doesn't have to be that specific stock; you just have to use the money for investing. Thus, if you already own a stock that pays out dividends, then you can borrow some amount to invest it in other things such that the interest you would pay on that loan for investment capital is covered by the dividend.

Sheesh!

This quote is from Motley Fool which just happened to be the first to come up.

"When a company issues common stock to raise capital, the proceeds from the sale of that stock become part of its total shareholders' equity but do not affect retained earnings. However, common stock can impact a company's retained earnings any time dividends are issued to stockholders."

The mistake you seem to be making is thinking that retained earnings and shareholders equity are the same thing.

Quote: kenarman

This quote is from Motley Fool which just happened to be the first to come up.

"When a company issues common stock to raise capital, the proceeds from the sale of that stock become part of its total shareholders' equity but do not affect retained earnings. However, common stock can impact a company's retained earnings any time dividends are issued to stockholders."

The mistake you seem to be making is thinking that retained earnings and shareholders equity are the same thing.

You're right in the sense that I am phrasing this very badly. I haven't really dealt with this since college, so I'm a bit rusty on the technicals. I know that retained earnings and shareholders equity are absolutely NOT the same thing. They're found with Shareholders' Equity on the liabilities side of the balance sheet. They wouldn't be an asset as any form of cash on hand (or other assets if insufficient cash---which really shouldn't be the case) would be used to reduce retained earnings. Not REDUCE, per se, but balances the two sides.

The point that I'm making is that dividend debits in cash can result in a reduction to shareholders equity.

I've also been somewhat simplifying the process because this gets accounted for in multiple financial statements. For example, on the Cash Flow Statement, that's a statement that doesn't care about retained earnings or shareholders' equity whatsoever. It would just show the cash outflow from the dividends paid out and then you'd want that to match CASH on the balance sheet.

Getting back to Retained Earnings, also according to Motley Fool:

https://www.fool.com/knowledge-center/can-dividends-be-paid-in-excess-of-retained-earnin.aspx#:~:text=If%20a%20company%20no%20longer,dividends%20except%20in%20extraordinary%20circumstances.&text=Retained%20earnings%20represent%20the%20accumulated%20earnings%20from%20a%20company%20since%20its%20formation.

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Finally, there is one situation in which a company can pay a dividend even with negative retained earnings. If the company is wrapping up its operations, then it can make dissolution or liquidation dividend payments to shareholders regardless of the condition of its balance sheet.

Which is why I said you wouldn't strictly have to have net profit, or even sufficient retained earnings, to make dividend payments.

Anyway, we've gotten really far away from the question of whether or not dividends paid qualifies as personal income.

As you can see in my post you quoted, I've already explained one mechanism by which you can take a tax deduction that could theoretically cover all of the dividends that were paid to you. There might be others, but I know even less about the tax code than I do corporate accounting.

I am going to make mistakes in talking about stuff like this, though. Not only have I never actually dealt with it outside of college, but I also wasn't even an accounting major. Some of my terminologies might not be exactly right, either. As mentioned, I know that the one deduction I detailed exists, but I don't remember what it's formally called.

I think a better case can be made for why there shouldn't be Personal Income Tax, at the Federal Level, than for dividends received (if we assume there is income tax) to be exempt. They shouldn't be exempt.

The reason why, in my opinion, is very simple. You buy Stock XYZ and it happens to be a stock that pays dividends. You own whatever number of shares in Stock XYZ, and after the dividends are paid (assumes cash dividend) you still own exactly that many shares. You haven't sold the stock whatsoever, so this dividend income is a return-on-investment and is investment income. It's not as if you sold the stock for a loss and got taxed on getting some of your money back.

Besides that, it's a completely voluntary transaction. If you don't want to deal with dividends, then don't invest in a stock that pays them.

Quote: Mission146

You haven't sold the stock whatsoever, so this dividend income is a return-on-investment and is investment income.

NO NO NO NO NO!

The income was operating income, from the corporation. The tax was paid there. The income was taken there. All that is happening is you are drawing off your share of the income.

Quote: AZDuffman

NO NO NO NO NO!

The income was operating income, from the corporation. The tax was paid there. The income was taken there. All that is happening is you are drawing off your share of the income.

The IRS disagrees and I disagree.

What entitles you, aside from the dividend, to a share of that income? Hence, my earlier point about how common shareholders often get exactly nothing in the event of a Chapter 7.

You'd have a better argument if all corporations paid dividends to shareholders.

Quote: Mission146

The IRS disagrees and I disagree.

What entitles you, aside from the dividend, to a share of that income?

The fact that I own part of the company. The IRS does not disagree, it is following the law as Congress made it. That it is law does not mean it is not double taxation.

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Hence, my earlier point about how common shareholders often get exactly nothing in the event of a Chapter 7.

That has zero to do with it. If there is a chapter 7 then there is an order of who gets paid first. Same as if your house gets foreclosed you do not get a share until all lienholders are paid off. Does that mean you do not own the house?

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You'd have a better argument if all corporations paid dividends to shareholders.

Whether they all pay a dividend or not does not mater. You are still an owner if you are a stockholder and the tax is still paid at the corporate level.

Quote: AZDuffman

The fact that I own part of the company. The IRS does not disagree, it is following the law as Congress made it. That it is law does not mean it is not double taxation.

Oh, really? Then why is it that you're entitled to pull funds from that corporation, but not corporations that choose not to pay a dividend?

You still own part of the companies that don't pay a dividend; why can you not make them pay a dividend?

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That has zero to do with it. If there is a chapter 7 then there is an order of who gets paid first. Same as if your house gets foreclosed you do not get a share until all lienholders are paid off. Does that mean you do not own the house?

Whether or not you own the house depends on if there is a loan on it. I would suggest, if a bank was able to foreclose on you, that you did not own the house.

In comparison, I own my car; it's all paid off. If the bank through which I had a loan came and repossessed it, then they have committed a major mistake and I would almost certainly sue them for the inconvenience.

Houses are a generally a secured loan with the house itself acting as collateral. It's not even comparable.

You own the STOCK which reflects some ownership in the company. However, your equity could prove to be zero, but guess what, you still technically own the shares!!!

In fact, it was just this year, I believe, that SHLDQ (Sears Holdings) finally got delisted. The SEC announced, in 2021, that they were going to be more aggressive about delisting companies like that.

Anyway, you still own your shares of stock; they just happen to have an actual value of nothing (aside from whatever the market will pay for a stock literally not tied to anything) and give you shares in a corporation that functionally no longer exists.

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Whether they all pay a dividend or not does not mater. You are still an owner if you are a stockholder and the tax is still paid at the corporate level.

What about employees? Should employees have their incomes taxed? You could make employees shareholders, which therefore, would make them owners of the company and then just say they are drawing from what they own commensurate with the work they put into it.

I guess respond to this post if you want to, but it had better be good. I'm done playing.