Tax 6-8 Identify characteristics of a form of real or potential dividends.

Question 1

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

ordinary dividends (corporate distribution of profits and earnings)

(LO 6-8)

Answer 1

Made out of current-year earnings and profits or from earnings and profits accumulated after February 28, 1913; taxable at capital gain rates to the extent they are paid out of corporate earnings and profits. Qualified dividends are subject to long-term capital gain rates. Qualified dividends are subject to a maximum tax rate of 15% if the dividends fall into the 25%–35% marginal income tax bracket. The rate is 20% for dividends in the 39.6% marginal income tax bracket. The rate is 0% if the dividends are in the 10% or 15% marginal tax bracket. These rates apply for both the regular tax and the AMT. Note that the preferential rates are available only to qualified dividends from stock; interest earned from CDs, bonds, and savings accounts is not eligible. Return

Question 2

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

policyholder dividends

(LO 6-8)

Answer 2

paid by mutual life insurance and other life insurance companies;

generally are exempt from income taxation (treated as a return of premium) except to the extent that the dividends received exceed the investment in the contract;

if from a modified endowment contract, are taxable if received as cash Return

Question 3

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

constructive dividends

(LO 6-8)

Answer 3

normally a disguised dividend such as excessive salary paid to an officer/shareholder or distribution characterized as a shareholder loan; taxed as ordinary income if construed as a dividend

Question 4

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

stock dividends

(LO 6-8)

Answer 4

distributions by a corporation to its stockholders in its own stock; generally nontaxable except if considered a property distribution

Question 5

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

stock rights

(LO 6-8)

Answer 5

shareholders are issued rights to subscribe to a new issue of corporate stock; rights have market value that may be taxable or nontaxable, depending upon whether it is a property distribution

Question 6

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

distributions of corporate property

(LO 6-8)

Answer 6

corporate distribution to shareholders of corporate-owned property—generally taxable to the recipient as an ordinary dividend. Note that the distribution of appreciated property by the corporation will generally result in a taxable event for the corporation. Return

Question 7

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

liquidating dividends

(LO 6-8)

Answer 7

a redemption of outstanding stock for cash or a distribution of assets to shareholders in exchange for stock; difference between cost of redeemed stock and amount received in liquidation by the shareholder is gain or loss from sale of a capital asset

Question 8

Dividends

Identify characteristics of each of the following forms of real or potential dividends.

redemptions of stock

(LO 6-8)

Answer 8

normally redemption is treated as sale of stock to the corporation (thus not a dividend); however, may be treated as dividend in certain situations

Question 9

Dividends

A ____ is the most common type of distribution resulting from the ownership of corporate stock, and it is a distribution to the shareholder of either cash or property out of the corporation’s current earnings and profits or earnings and profits accumulated after February 28, 1913.

(LO 6-8)

Answer 9

dividend

Question 10

Dividends

Karl Knight bought 5,000 shares of XYZ Corp. common stock on July 1, 2016. XYZ Corp. paid a cash dividend of 10 cents per share. The ex-dividend date was July 9, 2016. Karl’s Form 1099-DIV from XYZ Corp. shows $500 in box 1a (ordinary dividends) and in box 1b (qualified dividends). However, Karl sold the 5,000 shares on August 4, 2016. Does Karl have qualified dividends?

(LO 6-8)

Answer 10

Karl held his shares of XYZ Corp. for only 34 days of the 121-day period (from July 2, 2016, through August 4, 2016). The 121-day period began on May 10, 2016 (60 days before the ex-dividend date), and ended on September 7, 2016. Karl has no qualified dividends from XYZ Corp. because he held the XYZ stock for less than 61 days during the 121-day period.

Question 11

Dividends

Sandy Anthony bought 10,000 shares of ABC Mutual Fund on July 1, 2016. ABC Mutual Fund paid a cash dividend of 10 cents a share. The ex-dividend date was July 9, 2016. ABC Mutual Fund advises Sandy that the portion of the dividend eligible to be treated as qualified dividends equals 2 cents per share. Her Form 1099-DIV from ABC Mutual Fund shows total ordinary dividends of $1,000 and qualified dividends of $200. However, Sandy sold the 10,000 shares on August 4, 2016. Does she have qualified dividends?

(LO 6-8)

Answer 11

She has no qualified dividends from ABC Mutual Fund because she held the ABC Mutual Fund stock for less than 61 days.

Question 12

Dividends

Securities on loan from a broker and in connection with a short sale often generate substitute payments in lieu of a dividend. These substitute payments specifically are not considered a qualified dividend under JGTRRA and [will / will not] qualify for the preferential rates.

(LO 6-8)

Answer 12

will not

Payments in lieu of dividends are generally paid with respect to stock that has been lent in connection with a short sale, on which dividends are declared before the short sale is closed. The dividends are paid to the short sale buyer. The payments in lieu of dividends are paid to the lender of the stock (by the borrower) to compensate the lender for not receiving the actual dividends. (RIA)

Question 13

Property Dividend

For the corporation that distributes a property dividend, the income tax rules are considerably different than for a cash dividend. A distribution of appreciated property is treated as if the corporation had sold the property to the shareholder for the property’s _____ _____ value.

(LO 6-8)

Answer 13

fair market

A corporation may recognize gain, but not loss, on the distribution of property to a shareholder.

Question 14

Property Dividend

if a corporation distributes equipment with a basis of $12,000 and a fair market value of $25,000, the corporation will recognize a gain of $_ _, _ _ _

(LO 6-8)

Answer 14

$13,000

Alternatively, if a corporation distributes equipment with a basis of $20,000 and a fair market value of $8,000, the corporation is not allowed to recognize the loss.

Question 15

Life insurance dividends

Taxable life insurance dividends are treated as ______ income.

(LO 6-8)

Answer 15

Ordinary

Question 16

Life Insurance Dividends

The general rule is that life insurance dividends are nontaxable as a refund of unused premium. However, the dividends are taxable to the extent the dividends received exceed the _____ in the life insurance contract.

(LO 6-8)

Answer 16

investment

Question 17

Dividends

Module Check

29. Policyholder dividends from a whole-life insurance policy are generally tax exempt. In which of the following situations would the policyholder dividend be tax exempt?
    a. The policyholder receives dividends greater than the investment in the contract.
    b. The dividend is from a MEC and is received in cash.
    c. The policyholder receives dividends that are less than the investment in the contract.

(LO 6-8)

Answer 17

c. The policyholder receives dividends that are less than the investment in the contract.

The dividend from a life insurance policy is typically tax exempt. It is taxable to the extent that the dividend received exceeds the investment in the contract. If the cumulative dividends received are less than the investment in the contract, the dividends are tax free.