02.14.2003
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Updates
On January 7, 2003, President Bush, as part of his overall economic stimulus package, announced a proposal that would, among other things, exclude dividends from taxable income, (the "Proposal"). Following this announcement, on January 14, the Treasury Department published a summary fact sheet explaining the Proposal and highlighting how it would stimulate economic growth. On January 21, the Treasury Department released a more detailed explanation of the Proposal, which was subsequently reproduced in the General Explanations of the Administration's Fiscal Year 2004 Revenue Proposals that was released by the Treasury Department on February 4. This update summarizes the Proposal in its current form.
Excludable Dividends
Under the Proposal, shareholders of a corporation generally would not be subject to tax on dividends paid by the corporation to the extent such dividends were paid out of income previously taxed at the corporate level. The intent of the Proposal is to subject distributed earnings to only one layer of income tax. To calculate the amount of dividends that would be excludable from income under the Proposal, a corporation would need to compute its excludable dividend amount ("EDA") for each year according to the following formula:
|
EDA |
= |
U.S. Income Taxes .35 |
minus
U.S. Income Taxes
For purposes of the above formula, "U.S. Income Taxes" means the amount of U.S. income taxes shown on the corporation's U.S. federal income tax return that was filed during the year prior to the year of the EDA calculation. For the year commencing on January 1, 2003, the EDA calculation would be based on the amount of taxes shown on the 2001 tax return the corporation filed in 2002. For example, a corporation that paid $35 of U.S. income taxes in 2001 would have an EDA of $65 for 2003. Shareholders of the corporation could therefore exclude from taxable income $65 of the dividends paid by the corporation in 2003. If a corporation's distributions during a calendar year exceeded its EDA, the excess may be taxed as dividends under current authority. For shareholders that are themselves corporations, excludable dividends received by them in a prior year and retained earnings basis adjustments (as explained below) for the prior year made with respect to stock owned by them would be added to such shareholder corporation's own EDA total, helping to ensure that multiple layers of corporate ownership do not result in more than one level of tax.
Retained Earnings Basis Adjustments
As an alternative to distributing excludable dividends, the Proposal would allow a corporation to allocate all or a portion of its EDA to its shareholders as an increase in their stock basis. The Proposal provides that shareholders would be permitted to increase the tax basis of their shares to reflect any retained earnings that have been taxed but retained by the corporation. This retained earnings basis adjustment
("REBA") would be tax free. As such, REBAs prevent shareholders from being taxed on the portion of appreciation in the value of their stock that is attributable to previously taxed and undistributed income. REBAs must be allocated in the same manner as a distribution would be allocated but cannot be allocated to preferred stock that is limited as to dividends. Corporations would be permitted, under certain circumstances, to make dividend distributions in later years that have the effect of reversing prior REBA allocations.
Shareholder Requirements
Under the Proposal, shareholders would be required to hold their shares for an applicable period prior to the dividend date in order to be eligible for dividend exclusion and REBA allocations.
Effects of Proposal on Other Tax Provisions
NOL Carrybacks:
Under the Proposal, the NOL carryback provisions would be revised so that NOLs of a corporation may be carried back only one year. If an NOL is carried back, the EDA for the current year must be recomputed, but EDA calculations for previous years would not be affected. The Proposal would not affect the carryback period for NOLs arising in tax years ending prior to January 1, 2003.
Tax-Free Reorganizations:
Under the Proposal, the tax-free reorganization provisions would be amended to provide for the carryover of the EDA and cumulative REBAs of an acquired corporation.
Accumulated Earnings Tax and Personal Holding Company Tax:
Under the Proposal, the accumulated earnings tax and the personal holding company tax would be repealed.
S Corporations:
Under the Proposal, the S corporation rules would largely remain unchanged. To the extent that income of an S corporation is subject to an entity level of tax, however, the Proposal would apply to S corporations.
REITs:
Under the Proposal, REITs would be able to pass through any excludable dividend income they receive to their shareholders as excludable income. REITs would also be able to pass through REBAs to their shareholders as basis adjustments. REITs would not be allowed a deduction for distributions that are designated as excludable dividends or as reversing prior REBAs. For purposes of the distribution requirements of REITs, excludable dividends would be treated in the same manner as tax-exempt interest.
Shareholder AMT:
The Proposal does not affect AMT. Excludable dividends would not be an AMT adjustment or preference.
Dividends Received Deduction:
Under the Proposal, the 100% deduction for certain dividends received will remain in place. However, the 70% and 80% deduction for certain dividends received would only be available for distributions of pre-2001 earnings and profits that are distributed before January 1, 2006, with respect to stock issued before February 3, 2003.
Foreign Shareholders:
Under the Proposal, the withholding tax on dividends would be retained for excludable dividend distributions and for distributions that reverse prior REBAs.
Retirement Plans:
The Proposal would not affect the rules applicable to retirement plans, such as 401(k) plans and individual retirement accounts. Thus, individuals would continue to be taxed on the earnings of such plans once they are ultimately distributed, even to the extent that such earnings consist of excludable dividends.
Private Foundations:
Under the Proposal, excludable dividends and distributions reversing prior REBAs would not be included in the calculation of net investment income.
Corporate Reporting Requirements
Under the Proposal, corporations would be required to provide annual information to shareholders on a revised Form 1099 indicating the amount of (i) excludable dividends, (ii) taxable dividends, (iii) return of capital and (iv) REBAs allocated.
Proposed Effective Date
The Proposal would be effective for distributions made on or after January 1, 2003, with respect to corporate earnings after 2000.
We will continue to monitor and provide further updates on the Proposal as it works its way through Congress.
