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Corporations and Law

Stocks and Dividends


Capital stock is the totality of stock of all kinds that a corporation has issued or may issue. On a balance sheet, capital paid-in stock is the historical investment that the founding shareholders made in the corporation in exchange for their original stock. The other portion of the capital stock is made of common stock sold subsequently. Other key stock terms include preferred shares, dividends, initial public offering, and buybacks.

Stock is all the shares of a corporation, representing the division of ownership. Stock is the capital (in other words, money or property) that a corporation raises by selling shares, which entitle shareholders to certain rights of ownership. Capital stock refers to the totality of shares of all kinds that a corporation is authorized to issue based on the articles of incorporation. On an accountant's balance sheet, capital stock is the money that the shareholders paid into the corporation in exchange for their original stock.

Companies can issue two types of stock. Common stock is interest in a corporation that includes specified rights, such as the right to vote, but no guarantee of a financial return. Common stock is the usual type of stock. Holders of common stock may generally vote to elect members of the board of directors and to choose some of the policies the corporation will follow. Although common stock may yield higher returns—in other words, make more money for its holder—it comes with substantial risk. There are no guarantees that the company will make money, and the price of the stock may rise or fall rapidly.

In contrast, preferred shares typically have a set value and dividend attached to them and limited or no voting rights but have priority rights over common stock in liquidation. If the corporation goes out of business, the company or its liquidator pays preferred shareholders before common shareholders but after creditors.

Some companies may also issue a hybrid stock. Hybrid stock usually consists of preferred shares with the option to convert into common stock at some future time. These shares are also called convertible preferred shares. Investors may buy or sell contractual options to the underlying stock. For example, an investor might sell an option to purchase stock if it goes up to $100. These are embedded-derivative stocks.

Types of Stock

The four main classifications of stock are common, preferred, hybrid, and embedded-derivative. Ownership rights, dividend payouts, and sale options vary depending on the type of stock.
A dividend is a proportionate share of the profits of the corporation that is paid to its owners, as declared by the board of directors. Because dividends are proportional, the more shares a person has, the more money they receive in dividends. They may be paid in the form of cash, shares of stock, or other property. If the shareholder is paid in the form of property, then usually the property is recorded at market value on the declaration date.

Companies typically pay dividends to their shareholders monthly or quarterly. It is common for companies to offer dividend reinvestment plans that use a shareholder's dividend to buy more shares. A buyback happens when a company purchases shares that it sold earlier. Buybacks are expensive but may lessen shareholders' control over the corporation. For example, EQUTI Inc. has 4,999 shares outstanding, which the same person seems to be buying. This could indicate a maneuver for hostile takeover. To avoid this situation, EQUTI buys back 2,501 shares so that the company maintains control of the outstanding shares.

Corporate Taxes and the Double Taxation Problem

Double taxation occurs when a corporation pays taxes on earnings and shareholders pay taxes on their dividends.

Dividends come from after-tax dollars, which means that they are not tax-deductible to the corporation and must be paid from the money left over after the corporation pays its taxes. Also, dividends are taxable income for the shareholders. Because of this, C corporations have the issue of double taxation. Revenue (minus expenses) is taxed at the corporate level and at the corporate rate. After this, a dividend is shared based on the profit of the corporation after taxes. This dividend is income for the shareholder, meaning that it is taxed a second time at the individual tax rate.

For instance, EQUTI Inc. made $100 in profit after expenses. Its tax rate is 21 percent, so it would pay $21 in taxes, bringing the profit to $79. If all of that profit is paid to its CEO and majority shareholder as a dividend, the $79 would be taxed at an individual tax rate, which is 15 percent for this example. The shareholder who received the dividend would pay $11.85 in taxes. The original $100 would ultimately have a value of $67.15 to that shareholder.

Double taxation applies to C corporations and not to S corporations. S corporations are pass-through organizations that bypass that first round of taxation. C corporations can sell shares in the form of stock on the stock market. S corporations cannot. Instead, S corporations distribute profits through profit sharing. Under the S corporation structure, the corporation's income is indistinguishable from the individual shareholder's income. This is very similar to the tax treatment of a sole proprietorship or a partnership. In both corporation types, the shareholder will receive a K-1 schedule, which shows the total income to the shareholder.