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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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.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.