What Constitutes a Constructive Dividend?

What Constitutes a Constructive Dividend?

Aconstructive dividendrefers to the non-cash distribution of assets or property by a corporation to its shareholders. This type of dividend is not paid in cash, but rather in the form of property or services provided to the shareholders. But what constitutes a constructive dividend, and what are thetax implicationsfor shareholders?

Definition of Constructive Dividend

A constructive dividend is defined as any distribution of property or services by a corporation to its shareholders that is not a formal dividend. This type of distribution is not made in the form of cash, but rather in the form of assets or services. The value of the distribution is considered income to the shareholder and is subject to taxation.

Examples of Constructive Dividend

Constructive dividends can take many forms, including the personal use ofcorporate propertyor assets, the payment of personal expenses by the corporation, and the payment of excessive compensation to a shareholder-employee. For example, if a corporation allows a shareholder to use its vacation home rent-free, this would be considered a constructive dividend.

Tax Implications for Shareholders

Constructive dividends are subject to taxation just like cash dividends. The value of the distribution is considered income to the shareholder and is taxed at the shareholder's individual tax rate. In addition, the shareholder may also be subject to penalties and interest if the distribution is not reported on their tax return.

Avoiding Constructive Dividend Issues

To avoid constructive dividend issues, it is important for corporations to maintain proper accounting and record-keeping practices. All transactions between the corporation and its shareholders should be properly documented and classified. In addition, corporations should avoid providing personal benefits to shareholders that are not available to all shareholders equally.

Conclusion

In conclusion, constructive dividends are an important consideration for corporations and shareholders alike. Corporations must be diligent in their record-keeping andaccounting practicesto avoid potential issues with the IRS. Shareholders must also be aware of the tax implications of constructive dividends and properly report them on their tax returns. By following these guidelines, corporations and shareholders can avoid potential problems and ensure compliance with tax laws and regulations.