IRS Seeks to Expand Extraordinary Dividend Rules

By Willens, Robert | Journal of Accountancy, September 1996 | Go to article overview

IRS Seeks to Expand Extraordinary Dividend Rules


Willens, Robert, Journal of Accountancy


Under Internal Revenue Code section 356(a)(1), when a shareholder receives both stock and boot in a reorganization, the shareholder's gain is recognized in an amount not more than the boot's value. Under section 356(a)(2) and revenue ruling 93-61, this gain is characterized as a dividend (to the extent the company has accumulated earnings and profits) if the exchange is considered a dividend.

Corporate shareholders historically have preferred dividend treatment because of the availability of the corporate dividends-received deduction (DRD). It also was thought that reorganization boot dividends were generally immune from the extraordinary dividend rules. (Those rules require a stock-basis reduction if the dividend exceeds certain statutory thresholds.) Now, however, in proposed regulations section 1.1059(e)-1, the Internal Revenue Service characterizes a reorganization exchange as a redemption. This is significant because any dividend resulting from a redemption that is not pro rata to all shareholders is automatically an extraordinary dividend.

Observation: Corporations will have less (or no) incentive to earn reorganization boot dividends because-- as extraordinary dividends--the income will give rise to stock basis reductions measured by the DRDs when the dividends are received. …

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