Dividends on the other hand are treated differently

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Unformatted text preview: est and Dividend Income double taxation Occurs when the already oncetaxed earnings of a corporation are distributed as cash dividends to stockholders, who must pay taxes on them. intercorporate dividends Dividends received by one corporation on common and preferred stock held in other corporations. EXAMPLE In the process of determining taxable income, any interest received by the corporation is included as ordinary income. Dividends, on the other hand, are treated differently. This different treatment moderates the effect of double taxation, which occurs when the already once-taxed earnings of a corporation are distributed as cash dividends to stockholders, who must pay taxes on them. Therefore, dividends that the firm receives on common and preferred stock held in other corporations, and representing less than 20 percent ownership in them, are subject to a 70 percent exclusion for tax purposes.8 Because of the dividend exclusion, only 30 percent of these intercorporate dividends are included as ordinary income. The tax law provides this exclusion to avoid triple taxation. Triple taxation would occur if the first and second corporations were taxed on income before the second corporation paid dividends to its shareholders, who must then include the dividends in their taxable incomes. The dividend exclusion in effect eliminates most of the potential tax liability from the dividends received by the second and any subsequent corporations. Charnes Industries, a large foundry that makes custom castings for the automobile industry, during the year just ended received $100,000 in interest on bonds it held and $100,000 in dividends on common stock it owned in other corporations. The firm is subject to a 40% marginal tax rate and is eligible for a 70% exclusion on its intercorporate dividend receipts. The after-tax income realized by Charnes from each of these sources of investment income is found as follows: Interest income (1) Before-tax amount $100,000 Less: Applicable exclusion Taxable amount (...
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This document was uploaded on 01/19/2014.

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