What is a Constructive Dividend? A Comprehensive Legal Overview
Definition & Meaning
A constructive dividend is a benefit that a shareholder receives from a corporation, which is treated as taxable income even though it is not officially labeled as a dividend. This type of dividend occurs when a corporation distributes profits to its shareholders without formally declaring a dividend or expressing an intent to do so. Examples of actions that can lead to constructive dividends include paying excessive salaries to shareholder-employees, providing loans to shareholders, or selling corporate property at below-market prices.
Legal Use & context
Constructive dividends are relevant in tax law and corporate governance. They are often scrutinized by the Internal Revenue Service (IRS) to ensure that corporations are not misclassifying payments to shareholders to avoid taxation. This term is particularly significant in corporate finance and tax compliance, where proper documentation and classification of payments are crucial. Users may find legal forms useful for documenting shareholder transactions or for tax-related matters involving constructive dividends.
Real-world examples
Here are a couple of examples of abatement:
Example 1: A corporation pays a shareholder-employee an annual salary of $200,000, which is significantly higher than the market rate for similar positions. The IRS may determine that a portion of this payment is a constructive dividend.
Example 2: A company sells a piece of equipment worth $50,000 to a shareholder for $30,000. The IRS could classify the $20,000 difference as a constructive dividend, leading to tax implications for the shareholder. (hypothetical example)