What are Dividends?
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DIVIDENDS Dividends to shareholders are taxable only to the extent the payments are made from either Net Income (current earnings and profits) or Retained Earnings (accumulated earnings and profits). * Return on Investment: EARNINGS AND PROFITS * Return of Investment: CAPITAL cannot be chosen by a taxpayer * Capital Gain: LIABILITIES When a corporation issues a simple stock dividend, the shareholder does not realize income. However, if the shareholder has the option of receiving cash instead, he/she must realize the value of the stock received, rather than the cash rejected. TAX BENEFIT RULE If a taxpayer obtains a deduction for an item in one year and in a later year recovers all or the portion of the prior deduction, the recovery is included in gross income in the year received. Example: In 1999 Mimi deducted as a loss a $1,000 receivable from the customer when it appeared the amount would never be collected. The following year, the customer paid $700 on the AR. Mimi must report that $700 as gross income in 2000. INCOME FROM DISCHARGE OF INDEBTEDNESS A transfer of appreciated property (FMV > AB) in satisfaction of debt is an event that triggers the realization of income.
If the taxpayer is in a business same as or similar to that being investigated, all investigation expenses are deductible in the year paid or incurred. When the taxpayer is not in a business that is the same as or similar to the one being investigated, the tax result depends on whether the new business is acquired or commenced. If actual acquisition or commencement occurs, the expenses must be capitalized or amortized over the period of 60 months or more. If new business does not launch, the deduction is not allowed. HOBBY LOSSES Business or investment expenses are deductible only if the taxpayer can show that the activity was entered into for the purpose of making a profit. Hobby loss rule applies if the activity is not engaged in for profit and the expenses are deductible to the extent of hobby income. In addition, the Code provides a rebuttable presumption that an activity is profit seeking, if it shows profit 3-out-of-5 years (exception for horse-breeding activity presumption is 2-out-of-7 years). Hobby expenses must be deducted in the following manner: (1) Otherwise deductible expenses (2) Expenses that do not affect AB Itemized Deduction, subject to 2% of AGI (3)
BAD DEBTS Noncollectible debt is a type of incurred by all businesses. We must distinguish business bad debts (from the business of lending money) from personal bad debts. The Code allows "above the line" deduction in both cases; however, the timing of deduction is different. Business Bad Debt is deductible as an ordinary loss in the year incurred. The deduction can be taken in the year of partial or total worthlessness (no need for final settlement). Personal Bad Debt is deductible only in the year of total worthlessness. Partial bad debt is not deductible unless there is a final settlement. Nonbusiness bad debt is treated as a short-term capital loss subject to all limitation. Bankruptcy is generally an indication of partial worthlessness of the debt, but it is not necessarily a final settlement in itself. WORTHLESS SECURITIES Worthless securities are not same as penny stocks; they are completely worthless. A loss is allowed during the year of worthlessness, and it is treated as capital loss deemed to have occurred on the last day of the taxable year. Example: Wilson bought $3,000 stocks of Wolt Corporation on May 1, 2001. The company went bankrupt and the stock became worthless on April 1, 2002. Since we deduct the capital loss on the last day of the taxable year, we will treat $3,000 as long-term capital loss (May 1, 2001 - December 31, 2002 = 19 months).
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