Academic journal article Journal of Accountancy

Dividends-Received Deduction from Portfolio Stock

Academic journal article Journal of Accountancy

Dividends-Received Deduction from Portfolio Stock

Article excerpt

One of Congress's goals is preventing taxpayers from taking undue advantage of the tax rules. To that end it passed IRC section 246A, which prevents corporations from claiming a dividends-received deduction against dividends from stock purchased using debt that generates an interest expense deduction.

To make its insurance subsidiary a leader in the field, OBH Inc. (formerly Berkshire Hathaway) borrowed $750 million in four separate transactions. The company deposited these loans in the subsidiary's bank account, which contained all the subsidiary's other funds. The subsidiary then used this account to purchase stocks and bonds.

During its investigation, the IRS "traced" the company's borrowed funds to several of its dividend-paying stock purchases and then invoked section 246A to reduce the corporation's dividends-received deduction. The taxpayer objected to the "tracing."

Result. For the taxpayer. Section 246A limits the dividends-received deduction for "portfolio stock" when there is related "portfolio indebtedness." Portfolio stock includes any stock owned by a corporation unless the corporation owns at least 50% of its outstanding stock; both sides agreed the dividend-paying stock at issue was portfolio stock.

"Portfolio indebtedness" refers to indebtedness that is directly attributable to an investment in portfolio stock. The tax code does not define "directly attributable." In the Congressional Record, however, the phrase describes a direct relationship between the debt and the stock purchase--the company either incurs the debt to purchase the stock or the debt is directly traceable to the stock purchase.

OBH said the first of these tests did not apply as it had borrowed the funds to expand its insurance subsidiary. The government claimed the subsidiary was adequately capitalized and, therefore, that OBH had borrowed the money to buy stock. …

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