constructive dividend

Constructive Dividend

In American taxation, any payment to a shareholder that is not classified as a dividend by the company. The IRS treats these payments as dividends and taxes them as such. Constructive dividends are most common in closely-held corporations in which shareholders are often also employees or landlords of the company. For example, if a company rents its offices from a shareholder and pays in excess of the offices' fair market value, then the IRS considers the company's rent (or a portion of it) as a constructive dividend. Unlike business expenses, which are tax-deductible, constructive dividends are taxable. Thus, the company from the example will not be able to write off its rent like most other companies do.

constructive dividend

A corporate payment to a stockholder that is characterized by the Internal Revenue Service as a dividend distribution even though the corporation calls it something else. For example, a small firm may pay an employee who is also a stockholder an excessive salary so that the payment can be used as a tax-deductible expense rather than as an aftertax dividend payment. The IRS may determine that part of the payment is a constructive dividend and then disallow it as a tax-deductible expense.
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However, an advance or loan to a shareholder must be a bona fide loan to avoid a constructive dividend.
The IRS would be hard pressed to impose a constructive dividend on the allocation of the corporation's opportunity to such new pass-through entity.
There has been some concern that a deferred compensation plan which covers only the majority or controlling shareholder/employee in a closely-held corporation might give rise to a constructive dividend, probably in an amount equal to the premium payments for any life insurance policy used as an additional funding vehicle.
If such an election is not made, or if requests for relief are denied, then the taxpayer may face constructive dividend (or capital) treatment.
In all of these cases, the Internal Revenue Service (Service) will attempt to reclassify part or all of the distribution as a constructive dividend.
In addition, in the prior year's third quarter, the Company redeemed all its outstanding shares of convertible preferred stock and recorded a one-time constructive dividend of $4.
From a tax point of view, there is no difference between a formal dividend and a constructive dividend.
Miller held that a diversion of funds may be deemed a return of capital only if the taxpayer could demonstrate that the distribution, at the time it was made, was intended to be a return of capital and not a constructive dividend.
The net loss per share included stock-based compensation expenses of $193,000 and a one-time, non-cash constructive dividend of $1,389,000 that resulted from repayment of the company's redeemable preferred stock prior to the maturity date.
The lack of dividend payments, even if salaries are in proportion to shareholdings, does not automatically mean that the compensation is unreasonable and a constructive dividend.
During the third quarter, the Company redeemed all its outstanding shares of convertible preferred stock and recorded a one-time constructive dividend of $4.
The Tax Court held that the sole shareholder of a corporation did not receive a constructive dividend when the corporation provided construction services to the shareholder at cost.

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