While cash hoarding may not be a conventional reaction to the holiday spirit of giving, it is likely a prudent move for some cash-strapped companies. That is especially true of real estate investment trusts, which may be better off paying out dividends in stock, rather than cash.
The National Association of Real Estate Investment Trusts (NAREIT) thought so too, and in response to the current liquidity crisis, was looking for ways to provide incentives to REIT shareholders to nudge them to take stock, rather than cash, out of the trusts. One incentive was to provide shareholders with a tax deduction. However, a tax code threshold — specifically having to do with a cash cap related to a dividend election option — would have to be reduced to sweeten the incentive.
As a result, NAREIT implored the Internal Revenue Service to lower the cash cap associated with the aggregate shareholder distribution to 5 percent. Last week, the IRS budged a little — albeit not as much as the trade association would have liked. In IRS Revenue Procedure 2008-68, the government delivered a cash preservation incentive to REITS that was in line with recent private letter rulings, and dropped the cap needed to qualify for the deduction from 20 percent to 10 percent.
The route to the final pronouncement is involved, but tax managers will likely not mind following the sinuous path to the benefit at the end. To start, consider Section 857(b) of the tax code. It states that a REIT’s annual taxable income is based on a formula that includes the deduction for dividends paid (see Section 11.) However, in this case, dividends to are narrowly defined by two other rules, Section 316 and Section 301.
Specifically, in Section 316, the payout is defined as any distribution of property “to which Section 301 applies.” That means the dividend, which affords the REIT a tax deduction, is a distribution of property that emanates from the corporation’s earnings and profits.1.
Ordinarily, a distribution of stock by a corporation to its shareholders is not a distribution of property to which Section 301 applies, and therefore cannot be a dividend. Indeed, according to the tax code’s Section 305(a), gross income excludes stock distributed by the corporation to its shareholders. However, there are several exceptions to this general rule spelled out in the subsections of the rule.
For example, Section 305(b)(1) overrides Section 305(a), and allows the dividend to be treated as a distribution of property to which Sec. 301 applies, if any shareholder has the option to decide whether the dividend will be paid in stock or property (which includes cash).2.
In fact, Regulation Section 1.305-2 clarifies Section 305(b)(1), noting that if any shareholder “has the right to an election or option” with respect to whether a distribution shall be made either in money or property, or in stock (which includes rights to acquire stock of the distributing corporation), then, the distribution of stock with respect to all shareholders is treated as a distribution of property to which Sec. 301 applies. That is the case regardless of whether the following applies:
• The distribution is made in whole or in part in stock or in stock rights;
• The election or option is exercised or exercisable before or after the declaration of the distribution;
• The declaration of the distribution provides that the distribution will be made in one “medium” unless the shareholder specifically requires payment in the other medium;
• The election governing the nature of the distribution is provided in the declaration of the distribution or in the corporate charter, or arises instead from “the circumstances of the distribution”;
• All or part of the shareholders have the election.