¹This is a brief summary of the change in law for dividends received by individuals; it is not intended to cover all provisions of the new dividend tax rate.

²Dividends received by corporations from domestic corporations can qualify for the Sec. 243 dividend-received deduction. Corporations can exclude 70% of dividend income (100% in certain cases of affiliated groups).

³Excluded from the definition of qualified dividends are dividends received from tax-exempt entities under Secs. 501 and 521, any amount allowed as a deduction under Sec. 591, dividends described in Sec. 404(k), dividends subject to the Sec. 246(c) holding periods (as modified) and dividends received from certain foreign corporations (foreign personal holding companies, foreign investment companies and passive foreign investment companies).

⁴See also the discussion below under Foreign Dividend Planning.

⁵A thorough discussion of these topics is beyond the scope of this article.

⁶Sec. 162(a) allows as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including (1) a reasonable allowance for salaries or other compensation for personal services actually rendered.

⁷There is a potential for an employment tax refund because of the recharacterization of salaries to dividends. However, in some cases, the IRS will maintain that the salary is disallowed as unreasonable under Sec. 162(a)(1), but will not treat the disallowed amount as a constructive dividend to the shareholder, so it will not affect employment taxes. Thus, it remains as compensation at the shareholder level. There is judicial support for disallowing compensation to a corporation as unreasonable without characterizing the receipt of the payment as a constructive dividend. Unless the IRS asserts constructive-dividend treatment, the payment will remain as compensation in the hands of the employee-shareholder; see Sterno Sales Corp., 345 F2d 552 (Ct. Cl. 1965).

⁸The Service typically raises this issue for S corporations that pay unreasonably low salaries to avoid employment taxes; see Rev. Rul. 74-44, 1974-1 CB 287 and Spicer Accounting, Inc., 918 F2d 90 (9th Cir. 1990).

⁹On a related matter, when there is a below-market shareholder loan under Sec. 7872(c)(1)(C), the forgone interest treated as a dividend to the shareholder under Prop. Regs. Sec. 1.7872-4(d) should be taxed at the new dividend tax rates. However, this will not be certain until dividends are defined in regulations.

¹⁰See Ralph D. Crowley, 962 F2d 1077 (1st Cir. 1992).

¹¹See Theodore C. Miller, TC Memo 1980-445; In re Clement Betpouey, Bank. Ct., ED LA, 9/3/98.

¹²See Prop. Regs. Sec. 1.302-5. A complete discussion of these proposed regulations is beyond the scope of this article; however, in general, a loss can be recognized for the remaining stock basis if specified criteria are met.

¹³This is commonly referred to as the Sec. 306 taint.

¹⁴See Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders (Warren, Gorham & Lamont, 7th ed., 1994), 8.65 (e.g., a termination of a shareholders interest would qualify under Sec. 306(b)).

¹⁵See Regs. Sec. 1.306-1(b)(2), Example 2.

¹⁶See Secs. 306(c)(2) and 316(a)(2).

¹⁷Corporate capital losses can be carried back three years and forward five years, under Sec. 1212.

¹⁸Sec. 1(h)(11)(B) states, the term qualified dividend income means dividends received during the taxable year. (Emphasis added.)

¹⁹See Sec. 951(a)(1).

²⁰Sec. 1248(b) limits on the tax paid by individuals for gains treated as
dividends.

²¹See the Example in Regs. Sec. 1.959-1(b), illustrating a cash distributions effect on taxable income in a year when there is also Subpart F income.