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Constructive Dividend

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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.

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.


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If a C corporation, with accumulated earnings and profits, assumes a shareholder's obligation to purchase another's stake in a business, the IRS may impute to the shareholder a constructive dividend (that is, reclassify it as a dividend distribution; see "Tax Pitfalls," at right).
18) A plan that does benefit shareholders, instead of employees, is not "for employees" and will be deemed a constructive dividend, in such case, the company will get no deduction for its payments and the shareholder will have to report the full premium cost as dividend income to the extent of the corporation's earnings and profits.
If such an election is not made, or if requests for relief are denied, then the taxpayer may face constructive dividend (or capital) treatment.
 
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