Taxation of stocks can be a complex tax item for a company and its stockholders. This article addresses some of the key points and considerations on taxation of stock dividends, taxation of stock sales, and taxation of stock redemptions.

• Payment in Kind Dividends’ taxation is based on whether they are common stock or preferred stock PIK dividends.
• Stock Sales typically result in tax consequences for the selling stockholder, but not the buyer.
• Stock Redemptions is typically a taxable event for the redeemed stockholder but may not be a taxable event for the redeeming corporation.

How are Stock Dividends taxed?

Dividends generally are paid either in either cash or additional shares of stock. Additional shares of stock are also known payment-in-kind or PIK dividends. Most investors are aware of tax consequences when dividends are paid in cash. However, they are often confused on how PIK dividends are taxed. The tax rules that apply to PIK dividends depend on whether the PIK dividend is paid on common stock or preferred stock. Below are some simple, but non-exhaustive key points.

1. Common Stock

Common stock PIK dividends generally are not taxable to the recipient under IRC Section 305 unless one of the exceptions applies. Some exceptions, for example, may include i) any stockholder can elect to receive the distribution either in stock or property (including cash), and ii) the distribution is disproportionate. For a more comprehensive list of exceptions and to determine if your common stock PIK dividends are taxable, please contact our firm.

If a stock distribution on common stock meets one of these exceptions, it generally is taxed under the same rules that apply to cash dividends.

2. Preferred Stock

Preferred stock PIK dividends, whether paid in the form of common stock or preferred stock, are generally taxed under the same rules that apply to cash dividends.

How are Stock Sales taxed?

The taxable sale of stock of a US corporation generally results in only a single level of taxation at the stockholder level. In certain cases, a stock sale can also be structured as either a tax-free transaction, or an asset sale for tax purposes.

1. Tax Consequences of the Selling Stockholder

A selling stockholder generally recognizes a capital gain or loss on the taxable sale of stocks. If the shares were held for more than one year, a non-corporate stockholder recognizes a long-term capital gain or capital loss.

2. Tax Consequences for a Buyer

A taxable sale of stock of a corporation generally is not a taxable event for the corporation or the buyer.  Instead, the buyer receives a cost basis in the corporation’s stock and the buyer’s basis in the corporation’s stock is later used to calculate the buyer’s taxable income or gain (or the amount of any loss) when such stock is disposed.

To determine how your stock sales will be taxed, please contact our firm.

How are Stock Redemptions taxed?

A redemption generally is a taxable event for the redeemed stockholder but may not be a taxable event for the redeeming corporation.

For the redeemed stockholder, a redemption for cash or other property is taxed either as a dividend or as a sale or exchange of stock. A redemption generally is taxed as a dividend unless one of the exceptions applies. A couple examples of such exceptions are: i) The redemption is substantially disproportionate to the stockholder; and ii) the redemption completely terminates the stockholder’s share ownership in the corporation. For a more comprehensive list of exceptions and to determine how your stock redemption is taxed, please contact our firm.

If the redemption meets one of these exceptions, it is treated as a sale or exchange of stock for tax purposes.

For the redeeming corporation, a redemption for cash generally is not a taxable event for a corporation. However, the redeeming corporation recognizes income or gain (but not any losses) on a distribution of property (other than cash).