Stock Dividends

• Pages: 187-200
• Author: Howard E. Abrams,Don A. Leatherman,Thomas J. Brennan

187

Chapter 6

STOCK DIVIDENDS

6.01 Overview and History

Before considering the taxation of stock dividends, it is

worthwhile to reconsider the taxation of cash and property

dividends.

1

Recall that a “dividend” is a distribution of property by a

corporation made to a shareholder with respect to the shareholder’s

stock, taxable as ordinary income.

2

Why is it that cash dividends, for

example, are includible by the recipient as income?

At first blush, cash dividends seem to be “undeniable accessions

to wealth, clearly realized, . . . over which the taxpayers have

complete dominion.”

3

Yet, upon closer inspe ction we see that such

dividends are not accessions to wealth, because cash dividends, or at

least pro rata cash dividends, reduce pro tanto the value of the

corporate stock held by the shareholders. More generally, no pro rata

distribution of corporate assets increases the wealth of the

shareholders but only transmutes part of the value of their shares

into the form of distributed property.

Why then are dividends includible in gross income? The answer

to that question touches on both the realization doctrine and the

double taxation of corporate profits. For better or worse, Congress

has decided that corporations should be treated as taxable entities

distinct from their shareholders. As a consequence, corporate profits

are subjected to a double tax, once to the earning corporation and a

second time to the corporation’s shareholders. In theory, both layers

of taxation could be imposed as corporate profits are earned at the

corporate level, with the shareholders taxed in some manner akin to

that of partners and S corporation shareholders. Congress has

always provided as to C corporations, however, that the shareholder-

level taxation is imposed only when the corporate profits are

distributed as dividends.

Imposition of the shareholder-level tax on only distributed

corporate profits follows from the principle that corporations and

their shareholders are distinct taxpayers. Undistributed corporate

profits increase shareholder wealth by increasing the value of the

corporation’s shares. Under the realization doctrine, the mere

1

See Chapter 4 supra.

2

Throughout this discussio n it is assumed that the distributing corporation

has sufficient earnings and profits to cover any distribution.

3

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).