The taxation of dividends is complicated by the fundamental fact that the income tax is primarily a personal tax, the rate imposed upon the net earnings of corporations being, in fact, although not in form, a device primarily designed for collecting part of the individual shareholder's tax at the time the corporation earns the money rather than when it distributes it in dividends. Dividends, consequently, come into the hands of shareholders with a part of their tax obligation. already met. This necessitates a troublesome adjustment to give proper credit to the shareholder. Other difficulties arise from the necessity of determining whether dividends represent distributions of surplus accumulated before or after March 1, 1913, from the nature of distributions in complete or partial liquidation, and from the desire to prevent the corporation from being used to avoid the payment of surtaxes.2 The various uncertainties which have surrounded the taxation of dividends are rapidly being settled through legislation and court decisions.3 SUMMARY OF IMPORTANT CHANGES IN 1924 Law PAGE NO. 1. The presumption now is that every distribution is out of profits, 3. Liquidating dividends are taxed as capital gains, not as dividends 4. Distributions in partial liquidation are treated as a return of capital, and are taxable only if, as and to the extent that they exceed the basis of the stock.. 5. Distributions in partial liquidation shall not, to the extent that they are properly chargeable to capital account, be treated as distributions of profits for the purpose of determining the taxability of subsequent distributions by the corporation..... 6. Distributions out of unrealized appreciation accrued since March 1, 1913, and out of depletion and depreciation reserves constitute a return of capital and are taxable only if, as and to the extent that they exceed the basis of the stock.. 808 817 831 832 830 816, 826 7. It is now specifically provided that the excess in 6 above is taxable.... 826 8. The presumption that distributions made during the first 60 days of the year are from profits of preceding years is cut out because it applied only for invested capital purposes, and thus is now obsolete.... 9. Distributions from "discovery" depletion reserves of mines are treated as return of capital and not as taxable dividends.. Dividends are taxable. 819 828 LAW. Section 213. For the purpose of this title. (a) The term "gross income" includes gains, profits, and income derived from .. dividends, ... Certain dividends are relieved from normal tax. LAW. Section 216. [Individuals]. For the purpose of the normal tax only there shall be allowed the following credits: 1 See page 815 et seq. 2 See Chapter XLV, “Tax on Undistributed Profits." In view of many unsettled cases relating to returns going back to 1913, it is deemed necessary to include in this chapter copious references to past regulations and decisions. For full details, however, the reader is referred to Income Tax Procedure, 1918, 1919, 1920, 1921, 1922, 1923 and 1924 editions. Section 234 (a-6) uses practically identical language for the similar deduction allowed corporations. (a) The amount received as dividends (1) from a domestic corporation other than a corporation entitled to the benefits of section 262, and other than a corporation organized under the China Trade Act, 1922, or (2) from a foreign corporation when it is shown to the satisfaction of the Commissioner that more than 50 per centum of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of section 217;" It is clear that the law does not exempt dividends from the normal tax when they are received from corporations which derive most of their income from sources within United States possessions, from corporations organized under the China Trade Act, or from foreign corporations 50 per cent or more of whose gross income for the preceding three-year period is from sources without the United States." Section 2018 divides corporate distributions into the following classes: 5 1. Dividends from earnings accumulated since February 28, 1913 (except by personal service corporations 1918-1921). [Section 201 (a).] 2. Distributions (tax-free) from earnings accumulated prior 3. Distributions in complete liquidation. [Section 201 (c).] 6. Distributions out of unrealized appreciation, accrued since The phrase reading "and other than a corporation organized under the China Trade Act, 1922," was added to the 1921 law by the China Trade Act, approved by the President, September 19, 1922. See page 811 for discussion of reason for limitation of credit. [Former Procedure] Under the 1909 excise tax law corporations were not subject to tax upon dividends received. Under the 1913 and 1916 laws they were taxed. Under the 1917 law they were taxed 2 per cent when out of 1916 or 1917 earnings and 1 per cent when out of 1913, 1914 or 1915 earnings, and exempt as to the 4 per cent war income tax. The 1918 law relieved corporations from any tax on dividends received from other corporations which were themselves subject to tax under the federal income tax law. Corporation income tax rates were as follows: 1913, 1914, 1915, I per cent; 1916, 2 per cent; 1917, 2 per cent and 4 per cent war income tax; 1918, 12 per cent 1919, 1920 and 1921, 10 per cent; 1922, 1923 and 1924, 121⁄2 per cent. 8 Quoted on pages 807, 812, 818, 826, 829, 830, 831, and 832. 7. Capital distributions. [Section 201 (d).] 8. Distributions by corporations which were classed as personal service corporations under the 1918 and 1921 laws. [Section 201 (e).] What constitutes a distribution?-Three main questions arise in considering distributions, viz.: (a) Was the distribution received? (b) Was it out of profits? (c) How shall those profits be determined? CONSTRUCTIVE RECEIPT.-The Treasury applies the doctrine of "constructive receipt" to dividends although the express rule now has been omitted from the 1924 law.9 The reason for the omission is stated by Treasury officials to be the desire not to cast doubt on rulings applying the principle of "constructive receipt" to other items, such as bond interest, bank interest, etc.10 Few stockholders in ordinary corporations have information as to when dividends are declared. Their records show only the receipts of dividends, even when accounts are kept on an accrual basis. It would be difficult for a taxpayer keeping accounts on a cash basis to make the necessary adjustments at the beginning and end of each year. Such stockholders who report dividends as of date of receipt will ordinarily be complying with the law because that is usually the date when the funds are unqualifiedly made subject to their demands. In the case of close corporations, however, the individual accounts of stockholders may be treated as bank accounts and it is reasonable to charge such stockholders with notice as to the dates when dividends are credited. LAW. Dividend Defined Section 201. (a) The term "dividend” when used in this title (except in paragraph (9) of subdivision (a) of section 234" and para 9 [Former Procedure] Section 201 (e) of the 1921 law contained the express rule of "constructive receipt" as regards dividends, the language used being as follows: LAW. Section 201. (e) For the purposes of this Act, a taxable distribution made by a corporation to its shareholders or members shall be included in the gross income of the distributees as of the date when the cash or other property is unqualifiedly made subject to their demands. . . . . Although the 1918 law did not contain this provision, the Treasury im posed substantially the same rule by interpretation. 10 The same rule however appears in article 1541. 11 'Refers to distributions by insurance companies (other than life). 12 graph (4) of subdivision (a) of section 245) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913. REGULATION. Dividends for the purpose of the statute comprise any distribution in the ordinary course of business, even though extraordinary in amount, made by a domestic or foreign corporation to its shareholders out of its earnings or profits accumulated since February 28, 1913. (Art. 1541.) It should be noted particularly that the regulation just quoted insists that the distribution shall have been made "in the ordinary course of business." The phrase evidently is meant to distinguish such dividends from liquidation or dividends extraordinary.13 Interest on deposits in a mutual savings bank which has no capital stock is not a dividend within the meaning of section 201, although in effect a distribution of profits.14 In a case under the 1916 law 15 the court was satisfied that certain stockholders could not be charged with the constructive receipt of their dividends, even though credited to their individual accounts in the books. The Treasury held in a case where a dividend was used by agreement of the stockholders for paying in the stock of another company, that such dividend had been "received" by such stockholders.16 In another case stock was sold, payment to be made in installments, the vendor depositing the stock in bank in escrow, and dividends on the stock reducing each installment. It was held that the vendees. had "constructively received" such dividends.17 Withdrawals by stockholders in 1917 and 1918 not covered by charge to surplus and credit to the stockholders as dividends until 1920, were held to be "dividends received" in the former years.18 Amounts distributed to stockholders of a merged bank out of assets not taken into the merger, were held to be "dividends received." 19 The crediting by a sole stockholder to his personal account of the surplus of a corporation was held to be a dividend to him.20 12 Refers to distributions by life insurance companies. 13 See page 826. 14 C. B. I-2, page 148; I. T. 1461. Park v. Gilligan, Collector, 293 Fed. 129. An appeal in this case was dismissed, 284 Fed. 1017. 16 C. B. I-1, page 12; I. T. 1336. See also C. B. III-1, page 24; A. R. R. 4919. 17 C. B. III-1, page 111; I. T. 1958. 18 C. B. II-2, page 80; I. T. 1872. 19 C. B. II-2, page 8; I. T. 1850. 20 C. B. III-1, page 24; I. T. 2023. |